Municipal bonds | Insight Investment

Market review

For December, The Bloomberg AAA Tax-Exempt Municipal Bond Index performance was positive across the short and middle part of the curve and negative on the long-end¹. The high-grade tax-exempt yield curve flattened, while the Treasury yield curve steepened. The ratio of AAA-rated tax-exempt municipal yields to US Treasury yields was tighter across the curve, with municipals slightly outperforming compared to Treasuries. The yield ratios decreased by 1 ratio in five years, ten years and thirty years.

The best performing states were The Virgin Islands, Montana and Puerto Rico. The weakest performers were Guam, Kentucky and Alabama. The highest outperforming revenue sectors were Leasing, Power and Industrial, while the weakest performers were Education, Transportation and Water & Sewer. By quality, AA-rated municipals were the strongest performers, followed by AAA, BBB and A-rated municipals, respectively. 

The US Agg-eligible taxable municipal index generated a total return of -0.56% in December. Spreads for the taxable municipal index were flat and spreads for the credit long index widened by 2 bps.

Monthly municipal issuance was $41bn, above the average for the month over the past five years. Taxable municipal issuance represented 6% of December’s supply.

Muni fund flows were positive for December, with inflows averaging $1bn per week. ETF fund flows were positive for December with inflows averaging $974m per week.    

Outlook

The Bloomberg Municipal Bond Index finished the year strongly in Q4 2025 with positive returns that outpaced Treasuries while the Bloomberg Aggregate Bond Index market overall delivered its highest annual return since 2020. A catalyst was the Fed’s rate cuts in October and December. Annual supply set a record near $580bn, up 14% year-over-year. Looking ahead, 2026 is expected to be another heavy supply year driven by growing needs to fund aging infrastructure, higher cost of capex, and waning of pandemic-aid. Municipal tax-equivalent yields for top tax rate investors continue to look attractive in our view versus other high-grade fixed income markets. This may continue to fuel solid demand from individual investors via mutual fund and ETF flows as well as direct purchasing, supporting SMA growth.

We believe Muni credit conditions should continue to remain stable, supported by very high reserves and cash balances that have accumulated in recent years and modest economic growth supporting tax revenues. Many segments of the market are facing credit headwinds as we head into 2026. Tariffs, federal job cuts, and the deportations of illegal immigrants could have negative impacts on economic growth in our view, which we believe could lead to some softness in income and sales tax receipts. At the same time, cuts in federal spending in areas such as Medicaid, “green” infrastructure initiatives, and federal disaster relief could pressure state/local budgets. The likely expiration of healthcare subsidies is a credit negative for hospitals, especially those operating in rural areas, while tuition affordability concerns combined with weak demographic trends are pressuring smaller colleges with weak endowments.

From a sector standpoint we maintain core favorable views on state and local general obligation bonds, utilities (water and power), public higher education, local housing, and transportation credits which we expect to 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.

Although federal policy shifts under the current administration have introduced some uncertainty for municipal credit, we think most sectors remain positioned to absorb potential pressure. That said, major rating agencies have assigned negative outlooks for 2026 to select sectors, notably Higher Education and Seaports. We recommend a more selective, risk‑aware approach – prioritizing balance‑sheet strength, liquidity, and operating flexibility. While mainland hurricane activity was absent in 2025, integrating climate risk into investment decisions remains essential.

Our duration stance is neutral to modestly long versus our benchmarks. During 2025 bonds maturing fifteen years and beyond underperformed shorter maturities – steepening the yield curve and creating compelling value out toward the long end. We believe this segment can produce attractive relative returns as demand is likely to pick up under a more accommodative Federal Reserve. A barbell curve posture may be favorable with exposure to short maturities which should benefit from further Fed easing while longer maturity bonds offer attractive yield in a relatively steep curve environment.