Municipal bonds | Insight Investment

Market review

In February, The Bloomberg AAA-rated Tax-Exempt Municipal Bond Index’s performance was positive across the yield curve. The market’s yield curve steepened modestly while the US Treasury yield curve flattened. The ratio of AAA-rated tax-exempt municipal yields to US Treasury yields was tighter on the front and middle of the curve and slightly wider at the long end of the curve, with municipals slightly underperforming compared to Treasuries. The yield ratios decreased by five ratios at the five-year part of the curve, four ratios at the 10-year part and increased by one ratio at the 30-year part.

The best performing municipal states were Alabama, Missouri and Kentucky. The weakest performers were Puerto Rico, Guam and Hawaii. The highest outperforming revenue sectors were industrial development revenue bonds (IDR), pollution control revenue bonds (PCR) and special tax and leasing bonds, while the weakest performers were resource recovery, tobacco and electric. By quality, BBB-rated municipals were the strongest performers, followed by A, AAA and AA-rated municipals, respectively. 

The Bloomberg US Aggregate-Eligible Taxable Municipal Bond Index achieved a total return of 2.98% in February, and credit spreads tightened by 2bp and spreads for the Bloomberg Municipal Index Taxable Bonds Long Index widened by 11bp.

Monthly municipal bond issuance was $38bn, above the monthly average for the last five years. Taxable municipal issuance represented 5% of February’s supply.

Municipal bond net fund flows were positive for February, at averaging $2bn per week. ETF fund net inflows averaged $911m per week.

Outlook

We expect 2026 to be another heavy supply year, driven by growing needs to fund aging infrastructure, the higher cost of capex, and waning pandemic-era aid.

We believe tax-equivalent yields for top tax rate brackets continue to look attractive versus high-grade fixed income alternatives. In our view this may continue to support solid demand from individual investors.

Municipal credit conditions should continue to remain stable in our view, supported by very high reserves and cash balances and modest economic growth supporting tax revenues.

Many segments of the market are nonetheless facing credit headwinds from tariffs, federal job cuts and lower migration, which may impact income and sales tax receipts. Cuts in federal spending in areas such as Medicaid, “green” infrastructure, and federal disaster relief could also pressure some state and local budgets.

The likely expiration of healthcare subsidies is potentially challenging for hospital fundamentals, especially in rural areas, while tuition affordability concerns combined with weak demographic trends may pressure smaller colleges with weaker endowments.

From a sector standpoint we favor core positions in state and local general obligation, utilities (water and power), public higher education, local housing, and transportation credits which may benefit from essential service demand, broad and reliable revenue streams, and in many cases explicit or implicit government support. We remain cautious on hospital bonds amid margin pressures and anticipated Medicaid cuts, with a tilt toward larger healthcare systems with dominant positions in growing markets, strong balance sheets, and those less reliant on government payors.