United Kingdom
Summary
In our view, several prevailing factors mean taxable US municipal bonds should continue to offer considerable advantages for fixed income investors relative to US Treasuries over the medium term.
- Municipal bond valuations have improved versus Treasuries
- Municipal credit conditions compare favourably amid record outstanding Treasury issuance
- Municipal bonds bear similar credit ratings to Treasuries, but with spreads akin to lower-rated investment grade corporates
Opportunity bequeathed by volatility
During the first half of 2025, several factors contrived to produce a challenging backdrop for municipal bond markets. Firstly, like other financial assets, the imposition of tariffs by the US during the first half of 2025 led to elevated volatility, while uncertainty around other policy changes stoked fears of higher inflation and federal deficits.
Secondly, the municipal bond market experienced a heavy supply calendar, with total issuance breaching $281bn1 due to increased construction costs and issuers motivated to pre-empt potential future federal policy changes. As a result, the asset class posted lower returns than other fixed income markets over the first half of the year. However, we believe these factors have created an advantageous outlook for municipal bonds that compares favourably with that of US Treasuries.
Municipal valuations have improved versus Treasuries
In our view, the challenging environment of the first half of the year means municipal bonds offer what could be an exceptionally attractive entry point for investors seeking to diversify their fixed income allocation away from Treasury holdings.
US municipal bonds now provide some of the highest yield levels seen in over decade: 10-year taxable municipal bond yields, while declining slightly from those observed at the beginning of the year, remain at levels comparable to those last experienced in 2013 at just under 5%, represented by the dark green line in Figure 1. As a result, taxable munis now offer a spread of 77bp over 10-year Treasuries, which are represented by the light green line below.2 In our view, these elevated yields provide the potential for attractive levels of total return.
Figure 1: Taxable municipal spreads have improved over US Treasuries since the start of the year1
In addition, we believe the opportunity for income and return is even more pronounced in other segments of the asset class, providing much greater relative value than other fixed income asset classes.
For example, 30-year taxable muni revenue bonds, which each derive their income streams from infrastructure assets, currently offer comparatively higher yields than general obligation bonds and developed market sovereign bond yields of the same maturity (Figure 2), including US Treasuries, as muni curve slopes steepened during the first six months of 2025.
Figure 2: Taxable municipal bond yields exceed many global sovereign bond yields at the 30-year maturity3
This steepening, driven by heavy supply during the first half of 2025 and concerns surrounding sticky inflation, means spreads between long-dated taxable municipal revenue bonds and Treasuries are now above the mean level of the last five years.
Figure 3: 30-year Taxable municipal revenue bonds spreads over 30-year US Treasuries4
Rolling down the curve
For investors with shorter investment horizons, we think the relative spread level is less important than the relative steepness of each curve. During the first half, the spread between 10-year and 30-year US Treasuries steepened by less than the spread between 10-year and 30-year taxable municipal bond yields, which sit at 55bp and 127bp respectively.5
This relative steepness may provide investors with the ability to enhance returns by ‘rolling down the curve’, an investment strategy which seeks to generate higher returns by buying bonds on the steepest part of the curve and selling prior to their maturity, in accordance with the investor’s time horizon. A roll-down strategy takes advantage of the higher yields on offer from longer-dated issues and the capital appreciation that occurs as the bond approaches maturity. Therefore, we believe investors can utilise the relative steepness of the 10-30 muni yield curve to potentially obtain additional return over Treasury investors attempting to pursue a similar strategy.
Taking these dynamics together, we think municipal bond yields represent an attractive entry point for investors seeking diversify their fixed income exposure away from US Treasuries. In our view, the argument becomes even more compelling when considering the disparity in fundamentals between the asset classes.
Municipal credit conditions remain resilient amid higher federal debt6
At present outstanding US federal debt amounts to $36.2 trillion, reaching a debt-to-GDP ratio of 120%.7 Unsurprisingly, the sheer volume of ongoing US Treasury issuance and apparent political willingness to continue running substantial budget deficits has raised some questions about the fiscal outlook of the US.
By contrast, in aggregate, municipal credit conditions remain supportive for the asset class, bolstered by healthy state balance sheets and prudent management of cash reserves. For example, state total balances – combination of cash reserves that state governments set aside to help cover unexpected budget shortfalls or revenue declines and general fund ending balance – remain near the highest levels seen in decades, projected to reach $287bn in 2026 (see Figure 4).
In addition, while the value of state total balances has fallen from the highs reached during the pandemic, the median level of state total balances as a percentage of expenditures at 21.9%, as projected for fiscal year 2026, remains significantly above the pre-pandemic levels.
Figure 4: State total balances remain near record highs5
Likewise, municipal fundamentals are further bolstered by strong revenue collection, with most states reporting revenue collections exceeding budget projections. In cases where revenues fell short, reduced spending helped maintain budget surpluses, allowing states to build reserves and reduce debt. In addition, the aggregate revenues are expected to grow by 1.9% in fiscal year 2025 versus fiscal year 2024, highlighting the strength underlying the municipal bond market. 6
Same credit rating as US Treasuries with spreads akin to investment grade corporates
Reflecting concerns with US fiscal trajectory, the Treasury market lost its final AAA rating earlier this year, with all three major ratings agencies assigning now rating the asset class as AA+8. For Treasury investors, we believe the ratings downgrade provides additional support for a reallocation towards taxable municipal bonds, given 19% of the Bloomberg US Taxable Municipal Bond Index is rated AAA, and the index is rated AA overall.
In addition, the taxable municipal bond index, despite boasting an aggregate credit rating equal to US Treasuries, provides spreads in excess of similarly rated US corporate bonds. In fact, taxable munis, as represented by the Bloomberg US Taxable Municipal Bond Index currently offer spread levels comparable to the BBB-rated Bloomberg US Corporate Total Return index, as exhibited in Figure 5.
Figure 5: US taxable municipal bonds offer spreads over Treasuries in excess of similarly rated corporate bonds9
Therefore, we think US taxable municipal bonds can offer an alternative to Treasury investors, providing access to high quality asset class with a similar credit rating while offering a substantial uplift in spreads more akin to levels of broader US corporate investment grade.
Why Insight for Munis
Having launched one of the first infrastructure US municipal bond strategies for overseas investors in 2017, the Municipal Bond Team at Insight Investment understands the varying needs of its global base of investors.
Highly experienced specialist munis team
Insight’s highly experienced investment and trading teams have operated through multiple market and business cycles, providing the ability to navigate the idiosyncrasies in the market to maximise the opportunity set and harness the unique attributes of revenue bonds.
Revenue bond focus
We believe revenue bonds possess several advantages over general obligation bonds, such as strong credit fundamentals, greater insulation from political risk, and historically attractive yields. We believe these characteristics, in combination with a focus on high-quality, stable issuers in economically strong services areas, represent bond income sources that are better insulated from economic slowdowns than tax-reliant general obligation bonds.
Exploiting opportunities in a fragmented market
The fragmented nature of municipal bonds and infrastructure projects financed, and a buyer base dominated by retail investors, provides a distinct opportunity to exploit market inefficiencies. Detailed credit analysis by a specialist team is required, in our view, to identify and assess the unique risks and characteristics of the underlying infrastructure assets and how they are being managed.
