The Week in Muniland

The muni market was overcome by macro forces and significant secondary market trading to once again underperform US Treasuries. The muni yield curve flattened, with two-, 10- and 30-year AAA yields up 45, 30 and 18 basis points (bps), respectively. The Bloomberg Municipal Bond Index (the Index) returned –1.81% last week, bringing year-to-date returns to –3.63%.
 

• Why it matters: The same themes persist in the broader fixed-income markets, including elevated oil prices, a resilient economy as seen through stronger-than-expected US Flash PMI data, a hawkish Fed, and elevated supply in both corporate and municipal bonds. Although muni bonds have sold off, the sell-off has been orderly. LSEG Lipper reported inflows of $633 million, recovering a portion of last week’s outflow. Much of the trading activity appears to be associated with tax-loss harvesting purposes, as exchange-traded funds gained $2.1 billion, while open-end funds lost $1.5 billion. Crossover buyers, such as banks and insurance companies, are beginning to purchase muni bonds given attractive relative values and yields.
   

The muni market is entering the “oversold” zone, as yields and relative value are becoming extremely attractive.
 

• Why it matters: We are sounding like a broken record, but if you liked munis yesterday, you have to love them today. Munis may get cheaper, but when the 10-year AAA muni is yielding 4.05%, which is the highest level in a decade (Display 1), investors take notice. That equates to a taxable equivalent yield (TEY) of 6.84%, which is higher than the taxable US Aggregate Bond Index of 5.46%! The price of the Index is below par at $96.29, while its yield has risen to 4.69%, translating to a TEY of 7.92%. The last time the Index yield was this high was back in August 2001. Munis have become significantly more attractive relative to US Treasuries (Display 2), while the long end of the yield curve, specifically the 10- to 14-year range, offers meaningful roll potential of nearly 90 bps (Display 3). We’ve seen prior periods when munis sold off; most recently was August–October 2023 when the Index was down 5.2%, only to rally 8.7% in November–December. For these reasons, we suggest investors consider leaning into a down market, not running away.
   

To get ahead of inflation, municipal bond investors don’t need a crystal ball. They need a framework.
 

• Why it matters: Municipal bond investors face persistent inflation risks from geopolitical shocks, elevated government debt, demographic shifts, resource constraints and other structural pressures. Because inflation erodes real bond returns, investors may benefit from combining strategic protection with tactical positioning.Traditional hedges have limitations: Treasury Inflation-Protected Securities offer direct inflation exposure but can be tax inefficient and create taxable “phantom income,” while municipal inflation-protected securities are typically small, illiquid and expensive. Pairing tax-exempt municipal bonds with Consumer Price Index (CPI) swaps may provide a more effective alternative by accessing large, liquid markets and offering two potential tax advantages:federally tax-exempt municipal income and favorable capital gains treatment for swaps held longer than 12 months. Strategically, CPI swaps can help protect portfolios when inflation exceeds expectations without requiring precise timing. They may also create tactical opportunities when markets underprice inflation risk. Over the past decade, realized inflation has exceeded expectations by an average of 95 bps, including significant gaps during 2021–2023. We believe a durable framework should combine strategic portfolio protection with opportunistic positioning.