The muni market got off to a volatile start in 2025. January and February posted gains, benefiting from a seasonal imbalance in supply and demand. The favorable market technicals reversed in March, and muni generally declined. Worries about the potential impact of President Trump’s tax-policy, as well as layoffs from the federal government workforce, may have further unsettled investors. For the first quarter overall, investment grade, high yield, and taxable muni bonds returned -0.22%, 0.82%, and 2.99%, respectively.1 Investors in the tax-exempt space continued to favor lower credit quality bonds, helping high yield muni bonds outperform investment grade munis.
Key takeaways:
With multiple Federal Reserve rate cuts predicted for 2025 and steady new issuance, we see opportunities in the muni bond market due to high absolute yields and strong fundamentals. In the near term, we expect continued financial market volatility. Munis may benefit, as they’ve historically been a refuge for investors during turbulent periods and may add value to a portfolio by helping to mitigate risk.
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Source: Bloomberg L.P., as of March 31, 2025. Investment grade municipal bonds are represented by Bloomberg Municipal Bond Index. High yield municipal bonds are represented by Bloomberg Municipal High Yield Bond Index. Taxable municipal bonds are represented by the Bloomberg Taxable Municipal Index. An investment cannot be made into an index. Past performance does not guarantee future results.
Source: Thomson Reuters, as of March 31, 2025. Municipal valuations grew more attractive, as muni bonds broadly lagged Treasurys. A key indicator of relative value is the municipal-to-Treasury (M/T) ratio, where the greater the ratio, the cheaper muni bonds appear compared to Treasurys. At quarter end, the thirty-year AAA-rated M/T ratio stood at its highest level since the November US presidential election, having risen 15 percentage points from its six-month low of 78% on December 11, 2024. The M/T ratios of five-, ten-, and thirty-year AAA-rated municipal bonds were 72%, 77%, and 92%, respectively, at the end of the first quarter versus 66%, 67%, and 80%, respectively, at the end of 2024. A yield curve is a curve showing several yields to maturity or interest rates across different contract lengths for a similar debt contract. The Municipal AAA General Obligation bond yield is represented by the Municipal Market Data proprietary yield curve of AAA-rated state obligation bonds, based on the institutional block size of $2 million-plus market activity in both the primary and secondary bond market. Past performance does not predict future returns.
The current environment suggests potential positive muni bond performance ahead. Here are key reasons to consider an allocation to tax-exempt munis now.
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While the muni market hasn't performed as expected, the pullback may have created an interesting entry point for investors before the historically strong seasonal period.
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Important information
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An investment cannot be made directly into an index.
All fixed income securities are subject to two types of risk: credit risk and interest rate risk. Credit risk refers to the possibility that the issuer of a security will be unable to make interest payments and/ or repay the principal on its debt. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa.
Municipal securities are subject to the risk that legislative or economic conditions could affect an issuer’s ability to make payments of principal and/ or interest.
The Bloomberg US Municipal Bond Index covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.
The Bloomberg High Yield Bond Index covers the universe of fixed-rate, non-investment grade debt.
The Bloomberg US Municipal Taxable Bonds Index is a flagship measure of the US municipal taxable investment grade bond market with greater than one year to maturity.
High yield bonds, or junk bonds, involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.
A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO) of the creditworthiness of an issuer with respect to debt obligations, including specific securities, money market instruments or other debts. Ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest); ratings are subject to change without notice. NR indicates the debtor was not rated and should not be interpreted as indicating low quality. For more information on rating methodologies, please visit the following NRSRO websites: www.standardandpoors.com and select ‘Understanding Credit Ratings’ under Rating Resources ‘About Ratings’ on the homepage.; https://ratings.moodys.io/ratings and select ‘Understanding Ratings’ on the homepage.; www.fitchratings.com and select ‘Ratings Definitions Criteria’ under ‘Resources’ on the homepage. Then select ‘Rating Definitions’ under ‘Resources’ on the ‘Contents’ menu.
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