Insights
Municipal bondsMunicipal bonds: Is this quiet market ready to be heard?
As signs point to further easing, municipal bonds are stepping into a new era where stability meets opportunity. Could the most understated asset class be poised for a breakout? A look at why this quiet corner of the market may deserve a closer listen.
Authors
Jonathan Mondillo
Global Head of Fixed Income
Miguel Laranjeiro
Investment Director, Municipals
Contributors
Joseph Lapsley
Duration: 8 Mins
Date: Dec 09, 2025
What if the quietest corner of the investment world is finally poised to speak up – revealing overlooked opportunities for communities and portfolios alike?
Municipal bonds (munis) remain a cornerstone for generating tax-advantaged income within diversified portfolios.
As we approach 2026, evolving market dynamics – including interest rate shifts, robust issuance trends, and changes in credit quality – are shaping new opportunities for investors.
Rates & realities
The forces behind municipal issuance
We believe the macroeconomic environment at this point in 2025 and into 2026 is characterized by a mixed labor market and sticky, though not accelerating, inflation. The Federal Reserve’s (Fed) trajectory is a focal point: experts anticipate a more accommodative stance, with potential rate cuts totaling 25–75 basis points (bps) in 2026, especially as new leadership may favor dovish policies.
Historically speaking, an accommodative interest rate environment tends to benefit the market as flows in the municipal market typically follow a treasury market rally (Figure 1). The end of quantitative tightening and robust issuance in short-duration instruments are expected to keep short-term yields elevated.
Figure 1. Municipal bonds flow cycle
Muni issuance has reached record highs, with projections for 2026 to eclipse previous years. This surge is driven by increased infrastructure spending and higher project development costs, signaling a structurally higher issuance environment Over 75% of US infrastructure is financed through the muni market, and state balance sheets are generally healthy, supporting further growth.1
Munis vs. Other fixed income options
We believe munis have demonstrated compelling relative value, especially in the latter part of 2025. Tax-equivalent yields for investment-grade (IG) munis outpace those of corporates by 90–95 bps, while default rates remain significantly lower – about one-sixtieth that of corporates.2,3 High yield (HY) munis offer even greater spreads, with a 216-bps advantage over HY corporates – well above historical averages.4,5
Short-term munis – particularly variable rate demand notes – have outperformed money market funds and Treasury bills (T-bills) on a tax-equivalent basis, making them attractive for cash management.6,7
In rate-cutting cycles, munis tend to maintain higher income levels for longer compared to T-bills and corporates, benefiting coupon-clipping investors.
Muni strategies & portfolio integration
We believe active management is increasingly vital in the muni space, given market inefficiencies and the diversity of issuers. We advocate a barbell strategy – pairing short and long maturities – over laddered approaches, to optimize income and potential price appreciation while managing interest rate risk. The intermediate part of the curve is less attractive due to its inversion.
Credit selection is crucial, especially in HY sectors. While idiosyncratic risks exist (e.g., transportation projects such as Brightline East), overall credit stress and defaults remain low.8 As active managers, we favor higher-rated HY bonds and defensive sectors such as healthcare and education, where spreads have widened and opportunities are emerging.
The rise of exchange-traded funds and separately managed accounts reflect investor demand for liquidity, low fees, and tax efficiency. State-specific strategies are particularly popular among residents of high-tax states, offering enhanced after-tax yields and flexibility for tax-loss harvesting.
Looking ahead
As we move into 2026, the muni market stands at an intriguing crossroads – shaped by macroeconomic shifts, evolving fiscal priorities, and technical dynamics that could redefine investor strategies. While 2025 was marked by volatility and supply-demand imbalances, the coming year appears poised for a more stable, albeit nuanced, environment.
Interest rate landscape + market technical
We believe the Fed’s anticipated rate cuts are likely to be the single most influential factor for munis in 2026.
After a prolonged period of higher-for-longer rates, easing monetary policy should help normalize yield curves and reduce uncertainty. This shift could improve the muni/Treasury ratio, making tax-exempt bonds more attractive relative to Treasuries and other fixed income instruments.9
For investors, this environment may support a rebound in total returns, particularly for intermediate and long-duration bonds, which have lagged in recent years.
Supply dynamics + issuance trends
Issuance surged in 2025 as municipalities accelerated projects ahead of rising costs and policy uncertainty. We believe that 2026 will see another significant year of primary issuance in the municipal market, with many predicting for supply to exceed 2025’s record setting pace. This increase in supply presents a unique opportunity for active investors to invest in the municipal market at historically attractive income levels while building a diverse municipal debt portfolio.
Credit fundamentals + fiscal resilience
States enter 2026 with strong reserves and disciplined spending plans, providing a cushion against economic headwinds. Revenue growth is projected at roughly 3%, slower than the post-pandemic surge but consistent with long-term norms. While federal support for programs like Medicaid is waning, most states have demonstrated flexibility in managing fixed costs and pension obligations.
For investors, this translates into continued credit strength across the investment-grade spectrum, even as credit normalization tempers the exuberance of prior years.
Sector themes + emerging risks
We continue to be constructive on credit, particularly the HY market as the market has underperformed in 2025, despite a relatively stable credit backdrop with below 1% default rate in the market. Moreover, the prospect of a lower interest rate environment should be constructive for this corner of the municipal market as investors reach for yield by dipping down in credit quality.
Housing
Housing remains one of the most reliable places to pick up spread without adding additional risk. Stabilized affordable housing projects and mortgage-backed program continue to produce steady cashflow regardless of the macro backdrop. The sector benefits from a combination of experienced underwriting standards, strong sponsors, state-backed housing finance agencies, reliable federal reimbursement streams, and historically high occupancy. Housing bonds continue to trade at higher spreads compared to bonds with similar credit quality in other sectors. Whether this is a result of market participants overlooking a near zero default rate, or simply misperceiving the risks, smart investors can continue to capitalize.
In addition, we expect the positive momentum in the continuing care and retirement community sector to continue as demand remands strong drive by the aging population of the country. We would favor communities that are focused on independent living offerings in areas of the country that are supported by stable housing prices.
Airports
Airports head into 2026 with solid balance sheets and steady demand despite the negative headlines and externalities the sector faced due to the government shutdown and other federally induced trauma. Airports, particularly in high-growth Sun Belt and Mountain West regions (e.g., Austin, Houston, Denver, Phoenix, Tampa, Miami, etc.) offer stable, cash-generative infrastructure at attractive yields. These large and mid-size airports are supported by strong regional economies that could support higher airline and passenger fees well above current levels.
An honorable mention is idiosyncratic airport-related projects like terminal redevelopments, special-purpose aviation financings, or stand along facility bonds, which sit adjacent to this stability but with more structural nuance. We believe they can offer wider spreads without a fundamentally different risk profile.
Potential risks
We continue to be cautious on project finance as persistent budgeting issues related to cost of labor and materials have caused these projects to become overleveraged, putting a lot of emphasis on execution risk. The increase in prices has taken from the premium once given to investors for this type of risk.
Portfolio positioning for investors
Against this backdrop, we believe investors should consider a barbell approach – combining short-duration HY munis for attractive tax-equivalent yields with longer-dated IG bonds to capture potential price appreciation as rates decline. Active management will be critical, not only to navigate technical swings but also to capitalize on relative value opportunities across sectors and geographies.
Final thoughts
Heading into 2026, we believe munis may no longer be the quiet corner of fixed income – they’re poised to speak loudly to investors seeking tax-advantaged income and portfolio diversification. Record issuance, resilient state finances, and a likely accommodative Fed create fertile ground for opportunity, particularly for active managers. While certain sectors carry risks, the overall credit environment remains stable, and relative value continues to stand out against other fixed income options. For investors, we believe this is a moment to listen closely. The muni market’s understated nature has often led to it being overlooked, but in an easing cycle, its voice grows stronger – offering compelling yields, defensive qualities, and strategic flexibility. A thoughtful mix of maturities and credit qualities, paired with active management, can help navigate inefficiencies and uncover emerging opportunities. For both seasoned and prospective muni investors, we look to 2026 as not just another year – it’s a timely call to reassess allocations and ensure portfolios are positioned to benefit from a market ready to make itself heard.
Endnotes
1 "2020 Municipal Bond Market in Review." Municipal Securities Rulemaking Board, January 2021. https://www.msrb.org/sites/default/files/MSRB-2020-Municipal-Bond-Market-in-Review.pdf.
2 Bloomberg Municipal Bond Index, December 2025.
3 Bloomberg Municipal Index Taxable Bonds, December 2025.
4 Bloomberg Municipal Bond High Yield (Non-Investment-Grade), December 2025.
5 Bloomberg U.S. Corporate High Yield Bond Index, December 2025.
6 Bloomberg U.S. Aggregate Index, December 2025.
7 Bloomberg U.S. Treasury Index, December 2025.
8 "Brightline Faces Record-High Yield Amid Debt & Ridership Struggles; MTA Earns Upgrade." MunicipalBonds.com, August 2025. https://www.municipalbonds.com/news/2025/08/15/brightline-faces-record-high-yield-amid-debt-struggles/.
9 The municipal/Treasury ratio, or muni/Treasury ratio, or M/T ratio, is a key metric for investors in municipal bonds indicating the relative value of these bonds compared to U.S. Treasuries.
Important information
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
High yield securities may face additional risks, including economic growth; inflation; liquidity; supply; and externally generated shocks.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
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