Municipal bonds: Income, resilience, and the return of relative value
After several years of rate volatility, municipals are offering something investors have been waiting for: attractive tax-adjusted income, firmer demand, and a market where active credit and curve positioning can still make a meaningful difference.
Duration: 5 Mins
Date: Jul 08, 2026
The municipal bond (muni) market enters the second half of 2026 with a stronger story than many investors may appreciate. Growth has slowed but has not stalled. Employment remains steady, and consumer spending has proven more durable than sentiment surveys might suggest (Chart 1).
Chart 1. Consumer spending remains resilient despite softer confidence
That matters because the municipal market is closely tied to the real economy. Tax receipts, essential services, infrastructure needs, and issuer flexibility all depend on the strength and durability of local and national economic activity. The backdrop is not without risk, but it appears more balanced than headlines often imply.
Corporate investment, including spending tied to artificial intelligence and infrastructure, continues to support growth. Payrolls remain firm enough to sustain consumption, even as higher prices and tighter financial conditions keep households selective.
There are also signs that inflation pressures are moderating, with stabilizing energy prices helping relieve pressure on businesses and consumers.1,2 Monetary policy remains cautious, but a higher-rate environment continues to reinforce the income opportunity across fixed income markets.3
What this could mean for investors
For municipals, we believe this combination of steady growth, moderating inflation pressures, and higher yields creates a favorable starting point: munis are no longer simply a defensive allocation.
In today’s market, they offer a combination of income, credit quality, and relative value that can help portfolios move from cash preservation toward more intentional income generation.
We believe the following considerations will be particularly relevant for investors in the months ahead:
- Credit fundamentals remain broadly sound, but dispersion is rising, making issuer selection more important than broad market exposure.
- Tax-exempt income is once again doing meaningful work in portfolios, particularly for investors moving beyond cash and seeking durable after-tax yield.
- Strong demand is helping absorb elevated supply, but price discipline remains essential as new issuance creates both volatility and opportunity.
- Curve positioning matters: we favor combining front-end income and liquidity with selective longer-maturity exposure where total return potential is more compelling.
Credit fundamentals remain strong
State and local government finances continue to reflect healthy underlying conditions, in our view. Tax revenues have been supported by both consumer activity and corporate profitability, contributing to stable and, in some cases, improving fiscal positions.
Many issuers also entered this environment with strong reserves. Rather than drawing down rainy day funds, municipalities have generally continued to build them, reinforcing balance sheet strength. Credit trends remain constructive as well. Upgrades modestly outpace downgrades, distressed credit events remain limited, and municipals continue to exhibit lower overall volatility than corporate credit.
Why it matters
Strong balance sheets give the market an important cushion. But the next phase is likely to be less about broad beta and more about issuer-level discipline. We believe that may create an advantage for active managers who can separate durable credits from those facing cost pressure, policy uncertainty, or project-execution risk.
Technicals
Demand is catching up
In our view, the most important change in 2026, in our view, has been technical: demand has returned with conviction. Investors are again paying attention to the value of tax-exempt income, and flows into the asset class have helped offset the pressure from a heavy new-issue calendar.
At the same time, issuance remains elevated, with the market on pace for another year of robust supply.4 Despite the heavy calendar, new deals continue to be well absorbed, often attracting strong oversubscription in the primary market.
That balance matters. Heavy supply can create volatility, but it also creates opportunity when buyers have the capital and confidence to absorb it. The market is increasingly being supported by renewed fund flows, continued ETF adoption, and steady separately managed account demand from investors seeking predictable, tax-efficient income.
In our view, this improving technical environment has been particularly beneficial for higher-yielding segments of the market, where stronger demand and attractive income levels have supported a meaningful rebound in performance.
Looking forward
We expect demand to remain a critical swing factor. If cash continues to migrate out of money markets and into longer-duration income strategies, municipals should remain well supported. But with issuance still elevated, selectivity and price discipline remain essential.
Income remains a central driver
Income is the center of the story. At current yield levels, munis can offer investors meaningful cash flow, particularly on a tax-equivalent basis. That income is not just a headline yield; it is also a cushion against periods of rate volatility and a more durable driver of total return than investors experienced during the zero-rate era.
Why it matters
The advantage of tax exemption is amplified in a higher-rate environment, making municipal income more attractive relative to other fixed income sectors. For investors, we believe, the opportunity is a rare combination: competitive income, historically resilient credit behavior, and the ability to tailor exposure by maturity, sector, and credit quality. That makes municipals both an income source and a portfolio construction tool.
Positioning across the curve
The yield curve is not offering the same opportunity everywhere. That is why curve positioning matters. We believe investors should be intentional about where they take duration risk and where they harvest income.
At the short end, yields are elevated relative to cash alternatives. Investors can pick up incremental income over Treasury bills or money market strategies while maintaining limited interest rate risk. Instruments such as variable rate demand notes play an important role here, offering floating-rate income with stable pricing characteristics.
Further out, value re-emerges in longer maturities, generally in the 8- to 15-year range, where investors may capture higher yields and potential price appreciation as bonds roll down the curve. By contrast, parts of the intermediate curve appear less compelling. Persistent demand from laddered portfolios and separately managed account strategies has compressed yields and reduced relative value in those maturities.
Why it matters
In this environment, we believe a barbell approach remains attractive: use the front end for income and liquidity, while selectively adding longer maturities where roll-down and total return potential are more compelling.
High yield
Attractive, but selective
High yield (HY) municipals have been one of the stronger areas of the market in 2026 (Chart 2), supported by better flows, stable fundamentals, and the search for tax-efficient income. But after a meaningful rebound, we believe the next phase will require more precision.
Chart 2. High yield municipals remain attractive relative to corporates on a taxable-equivalent basis (TEY)
In our view, the most compelling opportunities remain in the higher-quality portion of the HY market, particularly among BBB- and BB-rated issuers. These credits often provide a favorable balance between yield enhancement and fundamental stability, allowing investors to capture additional income without assuming the elevated risks associated with lower-rated segments.
Relative value also remains supportive. HY municipals continue to compare favorably with corporate HY, reflecting lower default rates and stronger historical recoveries.
That said, credit dispersion is increasing. Some project finance sectors face pressure from rising construction costs and execution risks, while areas such as housing-related bonds may offer more stable opportunities supported by ongoing demand and issuance.
Looking forward
As the market becomes more differentiated, we believe returns will be increasingly driven by issuer selection rather than broad market exposure. This is where our approach matters: focus on credits with durable revenue streams, manageable leverage, and clear use-of-proceeds discipline, while avoiding areas where headline yield does not adequately compensate for execution risk.
Structural support remains in place
Beyond cyclical factors, we believe structural support remains powerful. Municipalities still need to finance infrastructure, housing, schools, transportation, water systems, and essential public services. That ongoing need should keep issuance elevated, while attractive tax-exempt income continues to pull investors back toward the market (Chart 3).
Chart 3. Structural demand continues to support the municipal bond market
The investor base is also evolving. Separately managed accounts now represent a meaningful share of demand and tend to exhibit more stable, buy-and-hold behavior, helping anchor market conditions (Chart 4).
Chart 4. Municipal assets under management in separately managed accounts
Together, these dynamics point to a market that is deeper, more resilient, and more nuanced. The opportunity is real, but it is not uniform.
Final thoughts
We believe munis remain well positioned for the second half of 2026, but the opportunity is not simply about buying the market. It is about understanding where the market is changing. Credit fundamentals remain sound, demand has improved, and tax-adjusted yields are still compelling. At the same time, supply is elevated, curve value is uneven, and dispersion is rising across sectors and issuers. That combination favors a forward-looking, active approach: emphasize income, maintain credit discipline, and use curve positioning to balance capital preservation with total return potential. In a higher-rate world, municipals can play a bigger role than a defensive placeholder. They can serve as a core source of tax-efficient income, quality, and diversification within fixed income portfolios.
