Municipals Thoughts from the Municipal Bond Desk

Tim: September saw municipal bonds turn in their weakest monthly performance since the global financial crisis.¹

Mark: It was a rough month for munis, that’s for sure. If it hadn’t been for a strong rally on the last day of the month, September would have been the worst month for municipal bonds since 1987!¹ To be clear, it had nothing to do with credit conditions, in my opinion. Inflation concerns, driven by the continuing US-Iran conflict and market expectations of a more hawkish Federal Reserve (Fed), led to a sharp rise in US Treasury yields. Municipal yields followed suit, as they often do. In September, the yields of one-year municipal bonds increased by more than 100 basis points, while the yields of 30-year municipal bonds climbed more than 60 basis points.¹ Municipals also became relatively cheap compared to US Treasury securities, with 10-year munis offering about 80% of the yield on US Treasuries of comparable maturity.¹ At the same time, the 30-year muni-to-Treasury ratio, a common gauge of relative value, rose to about 95%.¹

Tim: Did we see money leaving the asset class as well?

Mark: Yes, when yields rise and bond prices fall, investors may become concerned about the potential for additional rate-driven weakness, which can fuel selling and fund redemptions. As I’ve said, I believe the pressure on the market to be a function of interest-rate volatility, not any deterioration in underlying credit quality. We have seen this pattern several times since the global financial crisis. The 2013 taper tantrum, the 2016 election period, the 2020 pandemic shock, and the 2022 transition in Fed monetary policy were all periods when significant moves in interest rates contributed to weakness in the municipal market.² In most of these episodes, I would point out that investment outflows followed the initial interest-rate decline but did not cause it. The 2010 credit scare was a notable exception, when concerns about credit deterioration played a much larger role. However, market worries ultimately proved to be unwarranted.² Today, credit-rating activity remains modestly favorable, ratings upgrades and positive outlook revisions outpacing downgrades and negative revisions. For the 2026 year to date through September 24, there have been 838 credit rating upgrades versus 815 downgrades, for an upgrade-to-downgrade ratio of 1.03x.²

Tim: I think this is an important distinction. If interest rates are the primary driver of the decline and credit quality remains resilient, can’t periods of forced or indiscriminate selling create attractive entry points for investors?

Mark: Exactly. If you’re looking for tax-exempt income and long-term value, today's yields are a compelling place to buy high-quality munis, particularly those rated AA or higher. History backs it up: higher starting yields have gone hand in hand with stronger long-term returns, and over the past 30 years investors have been paid for taking duration risk when yields were elevated.³ For example, the Bloomberg Municipal Bond Index produced an average 12-month return of 7.0% when 30-year municipal yields were above 4.5%, while the same index returned just 4.2% when 30-year municipal yields were below 4.5%.³ Put differently, moments like this one tend to look a lot better in hindsight than they feel today. 

Read the complete article, including munis by the numbers.