What summer repricing signals for muni investors and issuers

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The municipal bond market is working overtime on messaging. The third quarter of 2026 is two-thirds complete and despite geopolitical-driven stress points that have sent long-term U.S. bond yields to generational highs, the asset class offers relative value, portfolio diversification, resiliency and credit reliability. While value in the municipal bond market is a constant, it should not be taken for granted, and we must understand how it is measured. Despite August's underperformance, absolute yields and intermittent relative value opportunities keep munis very much in demand against a wall of supply.  

Evolving market conditions signal the importance of active security selection with a keen eye not only on fundamental credit attributes, but also on a strategic response to policy shifts, funding uncertainties and cyclical forces. Although muni credit quality remains favorable and allows for strategic portfolio allocation and diversification, the upgrade/downgrade spread continues to narrow, with downgrades surpassing upgrades in certain sectors. Ample new-issue supply with broadening names promotes buyer selectivity and supports secondary market liquidity. 

Monetary policy stands at a defining crossroads with Federal Reserve Board Chair Kevin Warsh and his colleagues vying for attention with Treasury Secretary Scott Bessent. Whether the Fed chair and the Treasury secretary are on the same page regarding interest rates, internal politics create an undeniable opacity. Nevertheless, investors seem to have waning patience for mixed signals and clearly a very steep yield premium is being extracted from the bond market. 

The Fed's 2% inflation target remains elusive, and as of this writing Fed funds futures contracts are pricing in a 65% likelihood of a rate hike at the September 15-16 Federal Open Market Committee meeting. Warsh, in the post since May, fully appreciates the sense of urgency surrounding the central bank's capacity to get policy right. This is not the time to relax forward guidance, and Warsh cannot rely upon the bond market to do the heavy lifting.   

The Iranian crisis continues without an off-ramp in sight, keeping oil at elevated levels and extending transport disruptions in the Strait of Hormuz. Military strikes throughout the region appear random, with little clarity surrounding provocation, and safe passage through the Strait remains compromised. While details of President Donald Trump's deal with Venezuela to tap into its vast oil reserves have not been fully disclosed, the likelihood of lower gas prices over the near term is extremely low and the plan carries significant implementation, political and funding risk.  

The application of artificial intelligence and its use cases — as well as cyber readiness — impact the public finance ecosystem in ways which have not been fully revealed. While investors show little appetite for being on the wrong side of the AI trade, corporate earnings and anticipated productivity growth from AI-tech-driven expansion have pushed equity market performance. The question to ask is, will the expected productivity gains through AI implementation have positive implications for the inflationary trajectory? Stock prices may become more volatile given the rise in Treasury yields and oil.

Data centers seem to be all the rage, but not without growing community and political opposition. The potential impact on electric utilities may not necessarily be positive, as outcomes will rely heavily on appropriate cost allocations across individual data centers, utilities and existing ratepayers. 

The capital-intensive nature of data center buildout — with associated load concentrations — could fundamentally change a utility's capital structure, rate-setting flexibility and overall risk profile. There is likely to be a reallocation of risk and it is up to the municipal bond market to appropriately measure the long-term viability of this risk reallocation.  

Munis entered August with an improved bias following July's huge selloff — which produced a 1.85% loss in the broad market index. Throughout the month, however, munis struggled to find their footing thanks to a challenging technical environment and an embattled Treasury market. Treasury securities, however, avoided the volatility and heavy losses booked during July. Throughout August, Treasuries traded in a relatively narrow range compared to munis. 

Second-half performance is exerting a measurable impact upon municipal bonds. Following July's outsized negative returns, August losses were comparatively muted with the Bloomberg municipal index losing 23 basis points, pushing year-to-date returns down to a modestly positive 20 basis points. Treasury market catch-up and technical fatigue finally dimmed the muni performance star that shined brightly at the halfway point. In my view, the "carry" attribution in August limited downside performance. 

Against this backdrop, I am less confident that munis will finish the year with modest single-digit returns. An easing supply picture and any meaningfully improved geopolitical signals could support initial performance expectations. Nevertheless, continued muni repricing last month further creates compelling entry points to capture fresh yield and income opportunities, and taxable equivalent yield calculations provide an investment sweetener. The key takeaway from August closely mirrors my July commentary: municipal bond performance can diverge from credit fundamentals, particularly when technical dynamics shift and macro uncertainties prevail. I would further add, broad muni performance could obscure significant differences among rating cohorts, maturities and structures.   

U.S. Treasury securities outperformed the broad muni index in August, posting a gain of 31 basis points. Year-to-date, however, munis are outperforming Treasuries (-0.53%), U.S. corporates (-0.40%), and U.S. total fixed income (+0.14%). Since the end of June, munis have lost 212 basis points of return, versus an 81 basis point deficit for Treasuries. Of course, munis finished the first half of 2026 at much higher returns, thus positioned to retrace more performance ground. 

Throughout August, benchmark MMD AAA 10- and 30-year yields advanced 24 and 9 basis points, respectively. Similar maturity Treasury yields rose 5 and 2 basis points, respectively. Parsing the Bloomberg muni performance data, one- to 10-year maturity buckets revealed positive returns in August (although the 10-year was less resilient), while 15-year and out cohorts finished in the red. Although some improvement was noted last month, the intermediate part, or the "belly," of the curve is underperforming (negative) the broader curve year-to-date.  

While interest rate volatility and inflationary pressures remain, August did not witness the type of significant selloff in long duration fixed income assets that was clearly present in July. Much of the muni underperformance and wider yield swings last month can be attributed more to muni supply pressure and a lagging response to Treasury market technicals, rather than to anticipated accretive benefits (although debated on several fronts as just a band-aid) from the U.S. Treasury's announced buyback initiative — scheduled to commence in September — to ease long-end pressure.  

The underperformance of the "belly" is largely explained by the heavy new issuance that has been structured within the 7-15 year maturity buckets, leading to wider spreads and more pronounced steepening within this range. The 2s/10s spread widened by 30 basis points in August, while the 15s/30s spread tightened by 31 basis points. 

As portfolios earlier in the year targeted the intermediate part of the curve as the "sweet spot" to book roll-down performance (realized capital gain as a bond moves closer to maturity and is sold at a higher price), like intermediate relative value ratios became expensive. Since this strategy works best with stable interest rates, second-half rate shocks left the belly of the curve vulnerable, given the inability of rich valuations to absorb the rate dislocation. 

Last month, all investment-grade indices showed negative performance, while high-yield posted 22 basis points of return to outperform the broader muni index. Investors continued to pursue yield maximization, both on a cyclically attractive absolute and taxable equivalent yield basis. Year-to-date, high yield is outperforming the broader muni index with a 2.74% return. 

High-yield performance placed the "carry" trade front and center against a backdrop of favorable credit fundamentals and better relative value opportunities from higher yields that help insulate portfolios during periods of extensive market volatility. Simply put, the high-yield space experienced attendant spread tightening and speculative investors were compensated for their higher risk tolerance.

Overall, August's high-yield performance was highlighted by noted gains in the hospital and transportation sectors. Negative returns were seen in the high-yield education and water & sewer sectors, signaling a wider space for spread widening. Interestingly, high-yield electric, hospital, and water & sewer are outperforming the broader high-yield sector year-to-date. High-yield Puerto Rico earned 15 basis points last month and is showing a gain of 3.79% year-to-date. Much of this reflects relatively more room for spread tightening (throughout outperforming months) as well as specific bets being placed on these sectors. 

Taxable munis outperformed the broader muni index in August, earning 41 basis points, as spread widening was more visible across the longer duration tax-exempt sphere due to technical fatigue. Taxable returns were supported by stronger relative value — with more attractive entry points available at the beginning of the month — as well as more pronounced "carry" attributes. These conditions positioned taxables in a better place to absorb rate shocks. 

All taxable maturity and investment-grade ratings buckets showed positive performance in August. Long duration and "Baa" cohorts outperformed their respective peers. I suggest the tighter correlation that generally exists between taxable munis and Treasury securities — given taxables' less insulated volatility from macro and geopolitical developments — was not a significant factor last month. Again, tax-exempts registered a larger selloff relative to Treasuries in August. 

Supply continues at a rigorous pace, with August far from a "sleepy summer" month. According to LSEG data, issuance approached $60 billion, a record for August. Monetary policy uncertainty, outsized bond deals, and the late timing of the Labor Day holiday were all contributing factors. Year-to-date, aggregate issuance is just under $400 billion, keeping the asset class on track for another record year. A wider acceptance of tighter monetary policy by the issuer community could accelerate issuance schedules. 

Like July, there were fewer oversubscriptions on new primary offerings in August, even though demand was resilient. Investor demands for concessions were met in order for supply to clear the market. Further, investors exhibited noted selectivity across sector types and structures last month. All in all, primary market activity adjusted well to the market repricing, with underwriters and buyers aligned to execute orderly deal flow.   

Investor appetite remained evident in August, given active flow activity for mutual funds and exchange-traded funds. While inflows slowed during the middle of August, according to Lipper data, the month recorded almost $4.35 billion in flows, with year-to-date flows approaching $50 billion.  

Interestingly, active flows are visible during times of significant market volatility, attesting to the strong demand for relatively favorable credit quality and compelling yield and income opportunities, given enticing entry points. I expect continued demand dynamics to support the current strong flow environment. Of course, the flow trajectory could be exposed to disruptive forces that even favorable technicals may not be able to offset. 

The FOMC meets next on September 15-16, and this session will deliver a revised Summary of Economic Projections. With rising inflationary pressures, it may be difficult to avoid higher rates. As stated earlier, fed funds futures contracts are pricing in almost a 65% likelihood of a rate hike at the September meeting. Let's recall that the July decision to hold the target range for the federal funds rate at 3.5% to 3.75% was not unanimous, as three dissenting officials voted in favor of a 25-basis-point rate increase. It is reasonable to expect this month's vote to reflect differing views. 

Warsh's comments at the recent Jackson Hole Economic Policy Symposium were clear in the sense that staying committed to the Fed's 2% inflation target was non-negotiable. While the market and certain FOMC participants may support a rate hike later this month, Bessent stated, "It is my belief that we've seen a supply shock, and traditionally you don't raise into a supply shock unless you see second or third order effects." 

In my view, recent evidence of cooler inflation and weaker hiring activity may keep a rate hike in the Fed's back pocket. The release of new data points ahead of the FOMC meeting will be analyzed very carefully, and the central bank does not want to take any missteps that could jeopardize its credibility.