United States held municipal bonds have reached peak investment. Despite record-low yields due to consistently low interest rates, record high investment led municipal bond funds to accrue $632 billion in assets as of June 1.

This comes in direct contrast to Puerto Rican municipal bonds. Reduced to junk status in 2014 by three major credit agencies, the island’s local, state, and national tax-exempt bonds make up the vast majority of its $70 billion debt.

On May 1, Puerto Rico defaulted on the first major scheduled payment on its municipal bonds. Gov. Alejandro García Padilla warns that the country will likely default on the fast approaching July 1 payment on its general obligation bond debt. Puerto Rico must restructure its debt to meet upcoming bond payments, but pending legislation will need to pass through Congress in order to prevent the default.

Puerto Rican municipal bonds often exert an oversized influence on the entirety of the US bond market. The tax-exempt status of most Puerto Rican bonds made them an extremely popular investment during more prosperous periods in the debt-riddled island’s history. Perpetual Puerto Rican bond debt should harm the overall US bond market. Hence, the continued high quality and relative stability of US-issued municipal bonds is relatively unexpected.

Municipal Bonds vs. Treasury Bonds

May’s relatively high investment in municipal bonds comes as a reactionary measure to the Federal Reserve’s expected change in approach to monetary policy. Economists predict the Federal Reserve will tighten US monetary policy this year, reducing the attractiveness of treasury bonds and increasing the popularity of municipal bonds. Tighter monetary policy in practice equates to employing higher interest rates, discouraging borrowing and encouraging saving. More pointedly, higher interest rates cause bond prices to decrease and bond yields to increase.

Treasury bonds are generally considered risk-free; as it is highly unlikely the US Treasury would default on a bond payment. However, two current factors drastically reduce the yield potential of treasury bonds. At the moment, the US securities yield curve is the flattest it has been since 2008, indicating long term treasury bond investments yield little more profit than do short term investments. This makes present investment in treasury bonds incredibly unattractive. Additionally, the potential for an increase in interest rates means other bond types will soon represent relatively safe and increasingly higher yielding investments.

Municipal bonds function as the direct, and increasingly popular alternative to Treasury bonds. Instead of investing in national government backed bonds, investors place money in the hands of local and state authorities. These investments are backed by local or state tax revenue or fees on public services, and are often tax-exempt.

2016 has marked a shift away from Treasury bond investment and toward municipal bond investment. In a first for 2016, May saw a month over month municipal bond issuance increase. Municipal bond funds have accrued $22.5 billion from direct investment since the beginning of the year, and have pulled in $39.6 billion from equity funds over the same period. As of June 1, municipal bond funds have seen 34 straight weeks of positive inflows dating back to last October.

Record investment has produced the unintended backlash of record low yields on municipal bonds. The Federal Reserve has yet to increase interest rates, preventing the predicted increase in bond yields from taking hold. Municipal bonds have yielded only 2.89% this year, markedly lower than Treasury, corporate, or junk bonds. This hasn’t yet discouraged investors, as the municipal bond market is predicted to stay strong throughout the summer months in anticipation of the tightening of monetary policy.