I just got a $10K bonus and wondered if I should put it in bonds. I hear news about high bond yields being bad, but isn’t that good?

“Headlines are treating higher yields as a warning sign,” Eric Kazatsky told Moneywise. “But for investors interested in putting their money to work, they’re an invitation.”

Here are the aforementioned warning signs: Yields on 10-year U.S. Treasury bonds are approaching multi-year highs. They are currently 4.9% as of September 10. To be fair, that is bad for borrowers, particularly homeowners, as mortgage rates — already high, averaging 6.71% according to Freddie Mac — tend to rise with Treasury bond yields.

Meanwhile, economists associate high Treasury yields with economic risk and uncertainty. There’s a lot of uncertainty surrounding the Iran war, upcoming midterm elections, the $40.1 trillion U.S. federal debt and speculation about whether Federal Reserve Chair Kevin Warsh will raise interest rates to tamp down inflation.

Such uncertainty leads to reduced demand for U.S. Treasury bonds. In classic supply-demand fashion, lower demand drives bond prices down. But the interest on every U.S. Treasury bond is guaranteed; it doesn’t fall. That means a lower-priced bond delivers a higher income stream — or yield.

As Kazatsky points out, that’s good news for investors. Just as a high yield is good for farmers who invest in crops and people who put money in a high-yield savings account, a high yield on government bonds is money in the bank for investors.

Right now, there’s one bond class delivering particularly good returns: municipal bonds, whose yields tend to rise along with U.S. Treasury yields.

Monetary advantages of high-yield municipal bonds

Morgan Stanley reports that high-yield municipal bonds are delivering yields as good as, and in some cases better than, yields on U.S. Treasury bonds, high-yield corporate bonds, investment-grade corporate bonds and mortgage-backed securities.

In August, Invesco strategists Mark Paris and Tim Spitz predicted that a record number of municipal bonds would be issued in the U.S. — a projected $57 billion. In August, New York City sold $1.5 billion in municipal bonds.

Kazatsky’s firm handled some of those transactions. MacKay Shield manages $85 billion in municipal bonds alone. He notes that such bonds are not subject to income tax. That’s appealing to wealthy New Yorkers who pay a 50% income tax when federal, state and municipal taxes are factored in.

“The municipal market is one of the last tax breaks out there,” he told Moneywise. “It’s a tax haven.”

Imagine someone with a $10,000 bonus invests that money in a tax-exempt municipal bond with a 4% yield. They will get a guaranteed annual income of $400 a year, tax-free, from that bond.

In contrast, Kazatsky said, if the same person were to buy a 10-year U.S. Treasury bond, they might get a higher 4.84% yield, but they’d be hit by federal taxes, as Treasury bonds are taxable. Assuming a top tax bracket, that would result in an annual after-tax cash flow of $285 on $10,000.

Today, an investor can earn close to 5% yields on long-term municipal bonds — the tax-free equivalent of a taxable investment with a 9% annual return.

It’s not just the tax exemption that appeals, he said. Investors see municipal bonds as a lower-risk option in an uncertain economic environment.

Kazatsky noted that historically, municipal bonds have had a lower default rate than corporate bonds during financial crises like the dot-com crash of the 1990s (when the Nasdaq index fell 77% in a single day), the Great Recession of 2007-2009 and a pandemic-related crash in March 2020 when the Dow Index dropped nearly 10%.