INSIGHTS

On October 06, 2025

AAM Viewpoints — The Return of The Long Bond

With the federal government entering an October shutdown, state and local governments remain open for business with municipal debt finishing off September with the best month for the market in over a year and a half. The Bloomberg Municipal Bond Index was up 2.32% in September — the best month since December of 2023 — in which the market was, ironically, up the same 2.32% and the best September for the market over 15 years. Municipals outperformed U.S. Investment Grade Corporates for the month, for only the third time this year, and the U.S. Treasury market, also for only the third time this year. Investment Grade Corporates (Bloomberg U.S. Corporate Bond Index) were up 1.50% in September, lagging municipals by 82bps (basis points), while the U.S. Treasury market (Bloomberg U.S. Treasury Index) was up 0.85%, lagging municipals on a relative basis by 147bps.

While the market was up across all tenors, the story for the month really was about the return of the long bond

The headwinds the municipal market has faced in 2025 are numerous and have been well documented. Rate volatility, legislative uncertainty and shifting supply and demand dynamics have all weighed heavily on the market in 2025. No area of the market was more impacted than the long end of the yield curve. To begin September, there was a whopping 760bps in relative underperformance for longer-dated bonds relative to the short end of the municipal yield curve. The 5-year area of the curve started September at 4.01% year to date, while the long bond component of the market (20 years+) was down 3.59%. The short end of the yield curve has produced positive returns every month, but two, this year, bolstered by a strong steepening trend across fixed income markets. The long end of the yield curve, after getting off to a decent start to the year, was down almost 550bps from the beginning of March to the end of July. Yield curve steepening for most of the year reflects fixed income markets forward pricing expectations that the Federal Reserve would begin cutting rates sometime in 2025, which came to fruition with a Federal Open Market Committee rate cut at the September meeting. The 5-year AAA benchmark rate was down 60bps across the year to start September contrasted with the long end of the curve, from 20 years and out, which was up approximately 40bps.

Municipal returns in September represented a significant deviation from the pattern in place all year. There have been instances of slight relative outperformance for longer-dated municipals this year, but September represented, by far, the strongest performance all year for longer-dated paper, both on an absolute basis and relative to the short end. The long end of the curve was up approximately 4% in September while 1–3-year bonds were up less than 15bps, and the 5-year was up less than 50bps. To end August, 15-year and longer maturities were all in negative territory on a year-to-date basis; by the end of September the entire curve was in the green for the year. The over 750bps of relative underperformance — when comparing longer term to short term municipals — on a year-to-date basis to start September, now sits at approximately 375bps. While in the green on the year to start October, the longer end of the municipal market is up less than 1% year to date, well behind the longer end of both the corporate and Treasury markets, which could imply there is still some room left to run.

September could mark an inflection point for tax-exempt municipal markets. It seems likely that returns could be much less bifurcated moving forward than they have been on a year-to-date basis. While less bifurcation does not mean no volatility, the ride for the long end of the market should be a bit smoother moving forward for a host of reasons. First, even after the rally the short end seems to remain overbought while the long end still appears oversold. Municipal-to-Treasury ratios remain in the low to mid 60% range out to 10-years which begins to strain the value proposition in tax-exempt municipals. This implies that an investor needs a 35% to 40% tax burden to break even versus Treasury, which still provides potentially attractive taxable equivalent yields for many but leaves little to no room for ratios to tighten further. As of late last week, the 10-year Municipal-to-Treasury (M/T) ratio was over 70% and the 30 Year M/T ratio was almost 90%. We think intermediate to longer-term bonds appear much more attractive on a relative valuation basis than the shorter end of the yield curve even after the strong September rally. In addition, it is likely not a coincidence that one of the best months for municipals in recent memory occurred over the same timeframe as the Fed embarked on an easing cycle. Not only is an easing cycle likely more supportive for fixed income, we believe it is a clear signal to investors that they should get out of cash and add some duration. Cash returns are unlikely to outpace fixed income returns during an easing cycle. The 3-month T-Bill — a proxy for money market rates — is down 30bps since the end of July, currently sits just under 4%, and is likely to continue to fall when the Fed continues to lower the Fed Funds rate.

Finally, while the economy remains on solid footing there does appear to be some weakness at the margins as it relates to labor markets. Some combination of the long end being oversold, the Fed cutting rates, and a bit of economic weakness are likely the drivers behind the 5.5 billion in inflows into the asset class in September. Secular concerns over long-term rates, such as the U.S. deficit, and a continuation of the record-setting supply remain headwinds for the market but there is an argument to be made that the ride should be less bumpy moving forward.

CRN: 2025-1003-12902 R