Municipal bonds posted negative returns in the first quarter, as a favorable start gave way to a more challenging rate environment. The year began with markets positioned for eventual Fed easing, which kept risk appetite firm and rate volatility low. In March, however, the tone shifted dramatically after the US and Israel launched military strikes on Iran, sending energy prices soaring. Interest rates rose on mounting inflation concerns and potential supply disruptions. While economic data pointed to slower growth, markets worried that the Fed’s hands would be tied by pricing pressure stemming from the standoff in the Strait of Hormuz. By quarter-end, Treasury yields had risen meaningfully across the curve, and tax-exempt rates moved in tandem.
For municipal bonds, the March correction stood in stark contrast to how the quarter began. Appetite for bonds was strong out of the gates and supply, while elevated, was manageable and well absorbed. By late February, the market even felt grabby, with buyers stepping in aggressively and spreads grinding tighter. That dynamic did not hold. When war drove broader rates higher, pressure built on municipal bonds just as seasonal technicals began to fade. Fund flows, which had been strong to start the year, slowed to a trickle before turning to outflows by quarter end. Even so, credit fundamentals held up well, with spreads largely unchanged. The curve continued to normalize, with a flatter front end beginning to steepen while the very steep long end flattened modestly. Ratios moved higher over the quarter, providing needed relief after testing historically rich levels earlier in the year.
Our trading activity in the first quarter focused more on relative value opportunities than any broad shift in positioning. New issue supply opened the year matching 2025’s record pace and when rates moved rapidly higher in March, issuance accelerated rather than pulling back. A number of mega-deals already on the calendar decided to price even amid the sloppy conditions. The heavy volume needed sizeable concessions to attract buyers and we stepped in aggressively on the most compelling deals. To fund those purchases, we trimmed positions in shorter callable bonds and intermediate bullets where spreads had compressed, focusing on high-tax specialty states that in-state residents were still paying up for. Many of those sales were executed at spreads through the AAA scale. In that way, spotty liquidity proved a positive, with the weaker pockets offering attractive entry points while the better bid segments allowed us to exit tighter positions. Trading activity picked up as the quarter progressed, reaching near-record levels in March. Duration extended modestly, a result we were comfortable with given the backup in rates.
Looking ahead, the market appears to have reset to a healthier place. First and foremost, yields are back to six-month highs and that should not be taken for granted. Remember, we went more than a decade following the financial crisis and rarely saw these levels. As importantly, ratios have cheapened and the curve has taken on a more normal shape. The long end, in particular, held in well during the correction and continues, we believe, to offer the most attractive value. At current levels, further weakness would likely begin to draw crossover demand, as we saw during similar periods last summer and the fall prior. As always, the path forward will depend in large part on broader macro conditions and how events in the Middle East filter through to global growth and inflation. For now, the municipal bond market feels well balanced, with a more typical pattern in rate movements and valuations that better compensate investors for the risks involved.
This represents the views and opinions of GW&K Investment Management and does not constitute investment advice, nor should it be considered predictive of any future market performance. Data is from what we believe to be reliable sources, but it cannot be guaranteed. Opinions expressed are subject to change. Past performance is not indicative of future results.
Indexes are not subject to fees and expenses typically associated with managed accounts or investment funds. Investments cannot be made directly in an index. Index data has been obtained from third-party data providers that GW&K believes to be reliable, but GW&K does not guarantee its accuracy, completeness or timeliness. Third-party data providers make no warranties or representations relating to the accuracy, completeness or timeliness of the data they provide and are not liable for any damages relating to this data. The third-party data may not be further redistributed or used without the relevant third-party’s consent. Sources for index data include: Bloomberg, FactSet, ICE, FTSE Russell, MSCI and Standard & Poor’s.
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Municipal Bond Market Commentary – 1Q 2026
Municipal bonds posted negative returns in the first quarter, as a favorable start gave way to a more challenging rate environment. The year began with markets positioned for eventual Fed easing, which kept risk appetite firm and rate volatility low. In March, however, the tone shifted dramatically after the US and Israel launched military strikes on Iran, sending energy prices soaring. Interest rates rose on mounting inflation concerns and potential supply disruptions. While economic data pointed to slower growth, markets worried that the Fed’s hands would be tied by pricing pressure stemming from the standoff in the Strait of Hormuz. By quarter-end, Treasury yields had risen meaningfully across the curve, and tax-exempt rates moved in tandem.
For municipal bonds, the March correction stood in stark contrast to how the quarter began. Appetite for bonds was strong out of the gates and supply, while elevated, was manageable and well absorbed. By late February, the market even felt grabby, with buyers stepping in aggressively and spreads grinding tighter. That dynamic did not hold. When war drove broader rates higher, pressure built on municipal bonds just as seasonal technicals began to fade. Fund flows, which had been strong to start the year, slowed to a trickle before turning to outflows by quarter end. Even so, credit fundamentals held up well, with spreads largely unchanged. The curve continued to normalize, with a flatter front end beginning to steepen while the very steep long end flattened modestly. Ratios moved higher over the quarter, providing needed relief after testing historically rich levels earlier in the year.
Our trading activity in the first quarter focused more on relative value opportunities than any broad shift in positioning. New issue supply opened the year matching 2025’s record pace and when rates moved rapidly higher in March, issuance accelerated rather than pulling back. A number of mega-deals already on the calendar decided to price even amid the sloppy conditions. The heavy volume needed sizeable concessions to attract buyers and we stepped in aggressively on the most compelling deals. To fund those purchases, we trimmed positions in shorter callable bonds and intermediate bullets where spreads had compressed, focusing on high-tax specialty states that in-state residents were still paying up for. Many of those sales were executed at spreads through the AAA scale. In that way, spotty liquidity proved a positive, with the weaker pockets offering attractive entry points while the better bid segments allowed us to exit tighter positions. Trading activity picked up as the quarter progressed, reaching near-record levels in March. Duration extended modestly, a result we were comfortable with given the backup in rates.
Looking ahead, the market appears to have reset to a healthier place. First and foremost, yields are back to six-month highs and that should not be taken for granted. Remember, we went more than a decade following the financial crisis and rarely saw these levels. As importantly, ratios have cheapened and the curve has taken on a more normal shape. The long end, in particular, held in well during the correction and continues, we believe, to offer the most attractive value. At current levels, further weakness would likely begin to draw crossover demand, as we saw during similar periods last summer and the fall prior. As always, the path forward will depend in large part on broader macro conditions and how events in the Middle East filter through to global growth and inflation. For now, the municipal bond market feels well balanced, with a more typical pattern in rate movements and valuations that better compensate investors for the risks involved.
Disclosures
This represents the views and opinions of GW&K Investment Management and does not constitute investment advice, nor should it be considered predictive of any future market performance. Data is from what we believe to be reliable sources, but it cannot be guaranteed. Opinions expressed are subject to change. Past performance is not indicative of future results.
Indexes are not subject to fees and expenses typically associated with managed accounts or investment funds. Investments cannot be made directly in an index. Index data has been obtained from third-party data providers that GW&K believes to be reliable, but GW&K does not guarantee its accuracy, completeness or timeliness. Third-party data providers make no warranties or representations relating to the accuracy, completeness or timeliness of the data they provide and are not liable for any damages relating to this data. The third-party data may not be further redistributed or used without the relevant third-party’s consent. Sources for index data include: Bloomberg, FactSet, ICE, FTSE Russell, MSCI and Standard & Poor’s.