The Week in Muniland

It was another firm week in the market as investor demand for municipals remained constructive. For the week, two-year AAA yields fell seven basis points (bps), 10-year yields fell four bps and 30-year yields were flat. The Bloomberg Municipal Bond Index returned 0.19% last week, bringing year-to-date returns to 0.93%.  

• Why it matters: Inflows and reinvestment cash continued to support the market, with investors adding $1.8 billion last week, according to Lipper data. This marks the eighth consecutive week of inflows, and year-to-date inflows now total ~$5 billion. Municipals continued to outperform US Treasuries (USTs) across most of the curve—particularly on the front end, where after-tax spreads tightened by as much as 11 bps. As we highlight below, January has historically been a favorable month for tax-exempts, and this year is following that familiar seasonal pattern. Month to date, the Index’s yield to worst has fallen by 16 bps, and after-tax spreads have compressed meaningfully (see Display 2). With valuations in the belly of the curve looking rich, we recommend that investors with flexibility shift a modest portion of their exposure in those maturities into USTs until valuations become more attractive. Next week’s calendar appears manageable, with roughly $11 billion expected to price.

December CPI was released last week. Headline inflation came in at 2.7% year over year, while core inflation rose 2.6%. Goods inflation increased 1.4% year over year.  

• Why it matters: Given that this was the first clean inflation release after the government shutdown, the print carried additional significance. Overall, inflation remained moderate and broadly consistent with November’s report, which had been interpreted cautiously due to shutdown-related distortions. The data reinforced expectations that the Fed would hold rates steady at its meeting later this month. Goods inflation remained positive and roughly in line with where it has been since August, with tariffs continuing to exert some upward pressure. Shelter continues to account for more than half of core inflation, and December’s shelter data resumed its pre-shutdown path, rising 3.2% year over year. With home prices rising slightly over 1% in the past year, further shelter disinflation is expected in the coming quarters. The broader economic picture remains mixed—economic activity appears solid for now, the labor market is characterized by both weak supply and weak demand, and inflation is above target but not reaccelerating. This backdrop gives the Fed room to pause in January and seek additional clarity before its next meeting in late March. As long as inflation stays relatively in check and eases throughout the year, the labor market will be the key determinant of future Fed decisions. We continue to expect rate cuts this year, and if the Fed does not engage in proactive easing, it could ultimately require more significant cuts later in the year.

The “January Effect” in the municipal market has played out so far this month. 

• Why it matters: The muni market is one that can experience periods of seasonal strength and weakness. January, however, is historically a period of strength, with the Index averaging a 0.4% return in January over the last 10 years. This positive seasonality is generally due to strong demand for bonds—both from dealers, which tend to finish years with lower inventories, as well as investors with cash to put to work. Based on Lipper data, January fund flows are typically the strongest throughout the year, with a 10-year average of $6.8 billion in inflows in the month. In addition to strong demand for tax-exempts, the beginning of the year tends to feature outsize reinvestment cash from coupons and maturities, further adding to the technical strength. That said, it is likely that market technicals will weaken at some point over the next few months. That scenario could be an opportunity for investors to add to their muni exposure at more attractive valuations.