Municipals US municipal bond quarterly market recap and outlook

First quarter 2026 recap

Key takeaways:

• The municipal market’s rally paused as geopolitical events drove an increase in interest rate volatility.
• Demand for municipals was strong, with positive investment flows in almost every week of the quarter.
• New issuance rose year over year, as state and local governments sought financing to complete a backlog of capital projects.
• Underlying municipal fundamentals remained supportive, with credit conditions broadly stable.

Municipal bonds delivered mixed results for the first quarter. Performance was strong early on, with municipals generating positive returns of approximately 2% over January and February, supported by favorable market technicals and solid credit fundamentals.¹ Market confidence remained intact even in the face of macroeconomic factors, such as a partial federal government shutdown in early February and shifting economic data that raised questions about the path of Federal Reserve (Fed) policy action. In March, the market’s momentum was interrupted by a surge in interest rate volatility, triggered by geopolitical events. Escalating hostilities in the Middle East prompted a broad-based selloff across global capital markets. Municipal bonds declined in sympathy with other asset classes, though their drawdown was relatively modest compared to equities and several other fixed income sectors. In this environment, municipals gave back much of their previous gains. For the quarter overall, investment grade, high yield and taxable municipals returned -0.18%, 0.71%, and 0.43%, respectively.²

Outlook

Recent volatility has been driven by macroeconomic uncertainty and geopolitical events, not credit fundamentals. Although some sectors of the municipal market came under pressure due to reduced federal support and inflation-driven cost pressures, credit fundamentals remained positive during the quarter. State and local government budgets appeared to be on solid footing, with the vast majority maintaining healthy reserves. While there has been a moderate slowdown in credit rating upgrades, they still exceeded downgrades during the first quarter, highlighting the strong underlying fundamentals.³

Going forward, we expect to see positive market momentum return, as history has shown that municipal bonds have done well following periods of stress. These episodes have tended to be short lived, with fundamentals ultimately reasserting themselves. In fact, from a historical perspective, current yields suggest a favorable entry point for investors willing to focus on long term outcomes.

Looking ahead, we see compelling opportunities in municipals. Steady issuance and ongoing demand for tax‑exempt income, combined with high absolute yields and solid fundamentals, support a favorable investment environment. We remain committed to our time-tested, long-term investment approach, leveraging our seasoned credit research team to identify market dislocations as we seek to add value for shareholders.

Read the complete quarterly update.

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