INSIGHTS

On September 15, 2025

AAM Viewpoints — Municipal Bond Renaissance?

The municipal (“muni”) bond market seems to have had a bit of a renaissance over the past few weeks as investors added a whopping $2.3 billion to muni mutual funds the week ending August 21. This was the largest inflow of money into the market since January of 2023. Part of the was due to large inflows into a single ETF which saw an inflow of $1.5 billion on its own. The thought behind the massive capital flow was that it was an account or advisor that reallocated the funds into the ETF. This was followed by $590 million the week ending August 28 and $672 million the week ending September 4, which showed that the one-time inflow was not a fluke.

These inflows have bolstered muni performance as of late, but there are always two sides to the coin. The muni market started the third quarter down 1% Year to date (YTD) compared to the 3% gain on U.S. Treasuries (TSY). The average 10-year AAA muni bond started the quarter with a yield of 3.10%. and the average 30-year bond started the quarter with a yield of 4.54%. This has since dropped to 2.76% and 4.26% respectively, which is great for investors who have put money into the market over the past couple of months but could leave investors currently putting money into the market wishing for more yield. 20-30 basis points may not seem like a big move over the course of a quarter, but a majority of this move has occurred since the beginning of September. On September 2 the 10-year ratio was still at 3.04% and the 30 year was at 4.61%. This is quite a sticker shock for investors who saw a plethora of investment grade 5% coupon muni offerings at par or a discount who are now looking at similar bonds in the 4.50% yield range.

The uncertainty about Fed rate cuts and the subsequent effect on the fixed income markets has also led to people piling into the short end of the curve. One of the primary metrics we use on the trading desk to gauge the value on different parts of the curve is the ratio of the AAA muni yield to the comparative TSY. We started the quarter with 5-year municipals yielding 68% of comparable Treasuries and 2-year municipals yielding 67% of comparable Treasuries. Short-end munis have since richened even more, with the current 5-year ratio at 61% and the 2-year at 58%. While it seems counterintuitive to put money to work in the short end at these ratios when the 30-year ratio at 91% provides great relative value, there has been no stopping the strength on the short end of the curve.

Despite the recent rally there could be plenty of opportunities for investors in the near term. September and October are usually weaker months with supply outpacing demand despite the strong start to September. Current 30-day visible supply is $11.5 billion, although actual supply is expected to be higher as municipalities are forced to issue more debt as construction costs increase and federal aid wanes. Another factor to keep an eye on in the short term is the FOMC (Federal Open Market Committee) meeting on September 17. It appears the TSY and muni markets are already starting to price in the anticipated cuts, but we will have to keep an eye on how the markets react to seemingly over or under cuts with inflation in check and the job market stagnating. We believe these factors, along with ratios still being too low/unattractive for sustained crossover or bank demand and the continued uncertainty stemming from policies in Washington, D.C., should provide entry points for investors wanting tax-free income.

CRN: 2025-0902-12816 R