With investors anticipating earnings surprises for US stocks, the outlook for municipal bonds is looking brighter.----- Transcript -----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Global Head of Fixed Income and Thematic Research for Morgan Stanley. Mark Schmidt: And I'm Mark Schmidt, Head of Municipal Strategy. Michael Zezas: And today, we'll be talking about the core of many investors' fixed income portfolios, municipal bonds. It's Friday, June 16th at 9am in New York. Michael Zezas: As our equity strategists continue to highlight the risk of earnings surprises for U.S. stocks, the outlook for the bond market looks considerably better. A soft landing, so call it, slow growth and slowing inflation, would mean favorable total return prospects across fixed income. In fact, even as the Fed's been raising short term rates, longer term bond yields have been falling as investors anticipate both inflation and growth to decline. So, Mark, for the benefit of listeners, tell us why this is a sweet spot for munis. Mark Schmidt: Thanks, Michael. Municipal bonds, high credit quality and tax exempt income are an opportunity for investors in high tax brackets right now. Credit quality for municipals can seem confusing, but we like to think of it in a pretty simple way. What's the outlook for tax collections? Income tax collections were mixed in April, but sales and property taxes continue to grow. Also, most state and local governments still have plenty of cash on reserve in case the economy performs worse than our economists expect. That cash comes from all the aid that the federal government provided, several hundred billion dollars, in fact, to municipal issuers in response to COVID. That's created a balance sheet buffer that can still support issuers today, even as growth slows. Now, even though credit quality remains pretty good, the good news is we don't think you need to take a lot of risks to enjoy the benefits of tax free income in your portfolio. Michael Zezas: And Mark, investors ask a lot about what the right maturity of bond is for their portfolio. What do you think investors should favor right now? Shorter or longer maturity bonds? Mark Schmidt: Longer maturity bonds generally offer higher returns, but of course, with higher risk as well. Right now, we actually see superior risk adjusted returns in a 1 to 5 year or 1 to 10 year latter. We'd look for investment grade credits in those shorter maturities for investors seeking higher income with higher risk. We'd recommend a barbell approach, one that blends short 1 to 5 year maturities with select maturities between 15 and 20 years. On the long end of the curve, we prefer very high quality AA bonds. With credit spreads and risk free rates at multi-year highs, we just don't think you need to reach for yield in this environment, especially as the economy slows. But Michael, one question that always comes up with regards to municipal bonds is the risk of the tax exemption changing, given how important tax free income is for municipal investors. Congress does change the tax code from time to time, do you expect major legislation out of Washington anytime soon? Michael Zezas: In short, no. Major tax reforms tend to happen once in a generation, and they tend to need one party to control both the White House and both chambers of Congress. And even then, a big tax code change needs to be their priority. So, the earliest this could possibly happen again would be after the 2024 election, so call it 2025. And then again, even then, it's not clear that even if one party were to take control of Congress and the White House, that this would be a priority for them. So in short, it's not something I'd be particularly concerned about. But Mark, turning it back to you. Munis helped to build all kinds of infrastructures in states and cities, colleges, hospitals, airports and toll roads. They all issue municipal bonds. What sectors do you like right now? Mark Schmidt: We thi