Muni Market Weekly Review
Municipal bond yields have remained steady near their early November levels despite above-average supply, supported by favorable fundamentals. This contrasts with more volatile US Treasury (UST) yields influenced by fresh economic data. Buyers are increasingly discerning, favoring 15-year maturities and lower investment grade credits, each yielding modest returns of around 0.2%. The spread between 10- and 15-year maturities has tightened by approximately 50 basis points, stimulating demand for value opportunities. In credit sectors, long-dated BBB-rated hospital bonds have maintained stable spreads, though some BBB credits like Chicago general obligations face pressures due to negative outlooks and budget challenges.
The main municipal market index rose 0.2% in November, reaching a 4.1% gain year-to-date. General obligation (GO) and revenue bonds showed similar returns, though revenues have outperformed GOs by about 85 basis points over five years, driven by investor preference for wider sectors offering higher yields. Housing revenue bonds led with a 5.6% gain in 2025, while hospital bonds trailed with a 3.5% gain amid concerns about ACA funding and financial health of some systems. Duration positioning favored short (1-5 years) and longer (15 years) maturities, each posting 0.2% gains in November and strong year-to-date returns. BBB-rated bonds slightly outperformed other investment grade categories, with a 0.3% gain in November and 4.0% to 4.3% returns for the year.
Credit Outlook
Municipal credit ratings remain historically high, with only slight softening in select segments such as lower-rated higher education, smaller utilities, and schools experiencing enrollment declines. Overall, there is no expectation of broad credit stress, as rainy day funds are projected to remain elevated into fiscal year 2026. This is supported by states moderating the growth of General Fund spending and maintaining strong liquidity positions. Of the 25 largest municipal issuers, 20 report liquidity ratios in the AAA range, reflecting robust balance sheets. However, the credit environment may shift in 2026 if economic indicators like unemployment and inflation worsen. While cash reserves are still favorable, they are trending lower, with median rainy day funds declining from 53.2 to 46.9 days between FY24 and FY25. Major states such as California, New York, and Texas continue to hold significant reserves, indicating relative fiscal strength.
State and local governments are actively preparing for these potential headwinds. A report by the National League of Cities notes concerns among municipal finance officers about preserving tax exemptions, managing higher project costs, and addressing new taxes on real estate transfers. Historical trends from the Federal Reserve show that in recessions, higher-rated municipal bonds (AAA) tend to outperform lower-rated bonds (single-A), suggesting that during periods of economic stress, investors often favor credit quality, potentially creating a market split where AAA and AA credits are sought for safety and below-investment grade bonds attract yield-oriented investors.
Technical Environment
November’s municipal bond supply was moderate at approximately $45 billion, down from the peak months earlier in the year. The smaller buyer base for tax-advantaged munis and high money market rates have constrained demand for short duration bonds. Yield curve conditions — with flat or inverted yields in the first 10 years — have discouraged active flows in that segment, prompting investors to seek yield either by extending maturities beyond 10 years or selecting lower-rated bonds. The cross-market ratio of municipal to Treasury yields has improved, nearing 70%, enhancing muni attractiveness in longer maturities.
Net supply, which accounts for maturities and calls against new issuance, is projected to be a net-negative $18 billion by year-end 2025, indicating more bonds maturing or being called than issued. Historically, such net-negative supply correlates with yield rallies, suggesting a potential year-end rally in munis. Municipal fund inflows totaled $277 million, including $144 million into ETFs and $133 million into open-end funds, indicating steady investor interest ahead of a sizeable $16 billion new issue calendar.
