Municipal Bond Market Commentary – 2Q 2025

Municipal bonds posted mixed returns in the second quarter, with gains in short-to-intermediate maturities and losses out long. The results reflected a significant steepening in macro rates, driven by trade policy, budget concerns and evolving Fed expectations. It all began with the early-April tariff surprise, which rattled the Treasury market and triggered the sharpest correction in municipal bonds since the Covid lockdown. As soon as the 90-day pause was announced, however, municipal bonds began to retrace those losses, with the short end recovering the most by quarter end. Along the way, sentiment got a boost when the industry learned that the Congressional tax bill left the municipal bond exemption intact, far from guaranteed after it appeared as a possible revenue source in a House report earlier this year. By the end of June, a sense of normalcy had returned.

The broader market was unsettled throughout the quarter, absorbing a steady drumbeat of policy and geopolitical shocks. April’s volatility gave way to a May selloff that was driven by fiscal concerns and foreign rate pressure. A downgrade to the US sovereign rating didn’t help. June brought calmer trading, with a growing consensus that softening data and tame inflation would soon push the Fed toward cuts. Fed Chair, Jay Powell continued to signal patience, but market pricing reflected more conviction. At the same time, the long end of the curve failed to rally, reflecting both the uncertainty around tariffs and deficits and lingering questions about foreign demand for US debt. By the end of the quarter, the Treasury curve was as steep as it’s been since 2021.

Our trading focused on taking advantage of historic volatility and a steepening yield curve. The market dislocations tied to the April selloff created opportunities to invest in a cheaper marketplace. Value surfaced in the secondary market as the new issue calendar temporarily ground to a halt. When the primary market re-opened, deals were priced to sell, with yields pushing to levels we hadn’t seen in years. With liquidity at a premium, we sourced bonds primarily through short-callable structures that held up well during the turmoil. As the quarter rolled on and the market began to stabilize, a steepening trend emerged. We added to this part of the curve, taking advantage of an unrelenting flow of new deals. Simultaneously, we moved out of shorter maturities and tight-trading names, picking up yield and spread in the process. Our duration extended modestly, though the curve positioning was the reasoning behind the shift.

We believe the municipal bond market enters the third quarter in a stronger position, with calmer conditions, more attractive valuations and a curve that remains steep by historical standards. The summer months typically offer a performance tailwind, and 2025 looks no different, with reinvestment flows set to accelerate and supply expected to ease from the first half’s record pace. Credit fundamentals remain sound, and the exemption is no longer in the headlines. Meanwhile, the Fed remains on hold as committee members await more clarity on the fallout from trade policy. While much will depend on the path of global interest rates, the case for municipal bonds looks stronger now than it has in some time.