I think that in this environment it is wise not to be too complacent about muni credit risk. This downturn is unlike past recessions and it may be hard to predict what happens based on history. Particularly if you are buying individual bonds, it would be a good idea to do some credit work to understand the risks you are running.
Certainly!
Similar to this downturn being unlike past recessions, we have a Federal Reserve on record that they will provide as much money to the system as necessary to stabilize things. There will be a lot more money coming, for cities and states as well. The Fed is now purchasing municipal bonds. In doing this, they are allowing lots of new issuances to come to market at historically low yields, and they will buy them up. Meaning, those municipalities which find themselves in financial trouble will have the ability to borrow at these all-time low rates and have a ready buyer with cash. There's going to be a mass rush to retire all high-yield outstanding muni debt and refinance for a pittance. There are ways for muni investors to take advantage of this situation immediately with just a little effort and research.
Now, as I see it, the big problem for muni investors, both muni bond investors and muni bond fund investors, is that once this gargantuan refinance takes place, coupons on muni bonds will be left at these low yields. There is no incentive to be taking yields of no more than 2% in the muni market (in my view) - the risk is too high at that point. Not only for the fact that there is always going to be some risk of default (they are bonds after all), but then you have the interest rate risk on top of it. Any increase in market rates will cause bond prices and bond fund NAVs to crater.
The Fed has already said no negative rates. So, to view munis as good investments going forward after the big refinance completes, you either have to believe that rates will stay at historical lows for years to come, and/or the Fed changes its stance and does take interest rates negative. However, as a result of flooding the market with money, clearly the risk of inflation needs to be considered. If we see inflation begin to rise above the 2% (or slightly higher) target, to fight it, there will be a need to raise interest rates...or watch as the prices of goods and services really get out of hand.
Interesting times, indeed!