Municipal Bond Market Commentary – 3Q 2025

Municipal bonds posted strong returns in the third quarter, led by September’s sharp move at the long end. July and August returns were dominated by curve steepening rather than broad price gains, with retail demand pinned to the front end while value built further out the curve. By September, the opportunity was too compelling to ignore. After months of record supply, a decelerating new-issue calendar met renewed demand from traditional buyers and crossover accounts, with long maturities seeing the most interest. Mutual fund inflows, steady all year, accelerated alongside the rally. Under the surface, spreads were steady as the market rewarded liquidity and clean structures. September’s long-end gains unwound most of the steepening from July and August, but the quarter still closed with the curve far steeper than where it began the year.

Broader rates also fell over the quarter, though only by single digits. A weaker labor picture gave the Fed room to cut by 25 basis points in September but an upgraded outlook for growth and inflation kept a more aggressive rally in check. Deficit worries and the prospect of heavier Treasury issuance continued to weigh on the back end, even as benign inflation prints and a late-month safe-haven bid provided support. The prevailing sentiment seemed to rest on a resilient economy, driven by a healthy consumer and a labor market that is holding up but showing signs of strain. The political noise around Fed independence and government shutdowns has kept uncertainty at the forefront, as has evolving tariff policy, the ultimate effects of which are proving difficult to predict. Heading into the fourth quarter, markets are pricing in a slightly more aggressive easing path than the Fed’s own projections, but a range of crosscurrents will determine how that plays out.

We continued a year-long trend of heavy trading activity in the third quarter as we looked to take advantage of the sharp steepening of the municipal bond yield curve. An unexpectedly large new issuance calendar in July and August provided us with the opportunity to execute these trades while also exploiting significant new issue concessions. The payoff was instantaneous as September brought a furious rally, especially out past 10 years. As yields fell and the curve flattened in September, we dialed back on extending further.

Municipal bonds enter the fourth quarter in excellent shape. Nominal yields remain well above their 10- and 20-year averages, and the curve is still steep enough to offer meaningful expected return from roll. Technicals are mixed in the near term. Supply has eased from its torrid pace but is still running more than 10% ahead of last year’s record, while reinvestment flows should remain muted until December. Ratios at the front end are stretched, leaving less cushion if broader yields back up, but value persists in intermediate and longer maturities, where roll and carry do more of the work. Credit fundamentals remain sound. States continue to budget conservatively and maintain elevated reserves, even as some have begun modest draws on rainy-day funds. Policy shifts in higher education and health care bear watching, but our exposure remains concentrated in larger, better-capitalized systems. The market enters October on solid footing, and we would look to use any near-term volatility as an opportunity to add at improved levels.