Municipals Thoughts from the Municipal Bond Desk

Tim: September was a tough month for municipal bonds, with prices falling and yields moving sharply higher. What’s going on in the market, and how should investors think about these moves?

Mark:  It was certainly a painful month, Tim. The Bloomberg Municipal Bond Index declined 4.36%,¹ as the sharp rise in yields put pressure on bond prices. But while those declines were difficult for investors, the resulting higher yields also give us a reason for optimism. As municipal yields rose to 15-year highs, the tax-equivalent yield for an investor in the top federal tax bracket reached its highest level since 2008.² That’s an important part of the story: for investors seeking tax-advantaged income, the market offered an opportunity to put money to work at more attractive yields. Looking at yields on a tax-equivalent basis also helps illustrate the value of that income when comparing municipal bonds with taxable alternatives. So, while we shouldn’t minimize September’s challenges, the repricing made municipal bonds worth a closer look, particularly for investors focused on longer-term income rather than short-term market moves.

Tim: Periods of high starting yields have been associated with stronger forward returns, haven’t they?

Mark: Yes, particularly over longer investment horizons, with a 93% correlation between starting yields and future 10-year returns.³ For example, the Bloomberg Municipal Bond Index yielded 3.15% on December 31, 2013, and its annual total return averaged 3.03% over the following 10 years.³ So, with that same index yielding 4.78% at the end of September,³ I think we are seeing an attractive entry point for investors.

Tim: That’s a good perspective to have. Switching gears—the 2026 mid-term elections are now only days away. How do you think the outcome could affect the municipal market?

Mark: I’d expect a limited impact, with interest rates and state-level policy developments likely to matter more for municipal performance than the mid-terms. Investors should watch state ballot measures, including Florida’s proposed property tax cuts and California’s income and wealth tax initiatives, which could have more direct implications for municipal credits.¹ Current polling suggests Democrats could retake the House while Republicans retain a potentially smaller Senate majority.⁴ A change in House control would shift legislative priorities, but major tax and spending measures would still require support from both chambers. Municipal investors will be watching efforts to raise the transportation private-activity bond cap, restore tax-exempt advance refunding, increase the bank-qualified debt limit, and protect the municipal tax exemption. Those priorities will compete for attention on a crowded congressional agenda that also includes defense authorization, government funding, and surface transportation reauthorization.⁴ Ultimately, I’d encourage investors to focus less on the election headlines and more on the policies that could affect municipal credit quality and tax-advantaged income.

Read the complete article, including munis by the numbers.