FINDING OPPORTUNITY AMID VOLATILITY
- Kyle Gerberding and Wesley Williams
- Apr 30
- 3 min read
Updated: May 1
In the ever-changing landscape of today's financial markets, where emotions and short-term reactions often override fundamentals, adopting a long-term perspective is more crucial than ever. Nobel Prize-winning physicist Richard Feynman once noted, "Imagine how much harder physics would be if electrons had feelings." This sentiment serves as a reminder that while markets may seem driven by emotion and sentiment, insightful investment strategies should remain anchored in objective analysis and historical data.
Municipal Relative Value
Recent market volatility, sparked partly by tariff-related headlines, triggered broad-based selling across asset classes, including municipal bond funds. As investors sought liquidity, municipal mutual funds experienced nine consecutive weeks of outflows through April 24th, including two straight weeks of more than $3 billion in redemptions during April. This pressure was exacerbated by seasonally weak technicals around tax time, when investors often sell muni holdings to raise cash for tax payments, compounding outflows and adding to market weakness.
Simultaneously, municipal new issue supply remains elevated. Following a record-setting $513 billion of issuance in 2024, supply is up another 15% year-over-year in 2025, with recent weekly volume regularly exceeding $10 billion. This heavy issuance, alongside fund outflows, has contributed to meaningful yield adjustments. Through April 28th, stated AAA municipal yields beyond five years have risen by an average of 50 basis points year-to-date and 56 basis points since March 1st. Additionally, the municipal yield curve has steepened, with the 2-10 year spread currently at +44 basis points after being inverted through August of last year. As a result, we believe the case for extending duration in the current environment is compelling.
These technical pressures have helped reset municipal-to-Treasury relative value ratios higher. As of close on April 28th, the 10-year AAA muni yield stood at 82% of the comparable Treasury yield, up from a one-year low of just 58%. The long end of the curve offers even more compelling value, with the 30-year ratio climbing to 95%, compared to its recent low of 79%. These elevated ratios represent a significant improvement in relative value versus other fixed-income alternatives, and taxable equivalent yields that offer near expected equity-like returns, particularly for investors in high-tax states.
Fundamentals Remain Strong
Despite recent volatility, municipal credit fundamentals remain solid. State and local tax collections have continued to surprise to the upside, and many issuers prudently managed pandemic-era federal stimulus, strengthening balance sheets and liquidity. While the pace has slowed, rating agency upgrades continue to outpace downgrades, reflecting the sector’s strong credit quality entering 2025.
That said, we acknowledge the headwinds that the tax-exempt market faces. While a reduction in federal support could lead to increased borrowing and downstream budgetary challenges, we believe that strong financial positioning and prudent fiscal management will allow most municipalities to weather these changes. Additionally, municipalities have proven resilient in prior periods of economic slowdown.
Finally, headline noise around the future of the municipal tax exemption has contributed to the surge in issuance, as some issuers have accelerated borrowing. While proposals to curtail or eliminate the exemption are gaining headline attention, our base case remains that the broad exemption will be maintained. Even in the unlikely worst-case scenario of full repeal, we would expect existing bonds to be grandfathered in, given the vast legal and constitutional challenges associated with retroactive changes.
Looking Ahead: Change in Muni Market Technicals
As we look ahead, the summer months have historically ushered in a surge of reinvestment demand driven by bond maturities and interest payments, often surpassing new supply, causing natural support for the asset class. With rising yields, enhanced taxable-equivalent income, and solid underlying fundamentals, we believe the municipal bond market presents an appealing entry point for investors seeking income, tax efficiency, and stability amidst a more volatile market environment.
APA-2504-58