Municipal Bond Market Commentary – 4Q 2025

Municipal bonds posted solid results in the fourth quarter, though gains were unevenly distributed across the curve. The momentum that began with the late third-quarter rally carried over into October, as robust investor appetite easily took down still heavy supply. The market consolidated those gains in November and December as issuance decelerated and demand settled into its usual seasonal pattern. Curve dynamics drove much of the differentiation in returns. Yields inside seven years actually rose for the quarter, while those at the longest end dipped modestly. The strongest segment was the 10- to 15-year area of the curve, which saw rates decline 15-20 basis points, pushing intermediate returns over 5% for the year. Despite the front-half flattening, nearly every portion of the curve finished the year meaningfully steeper than where it began, particularly beyond ten years.

The broader rate backdrop remained unsettled, with Treasury yields moving in different directions across the curve. Short- and intermediate-term rates declined modestly, while longer-dated yields drifted higher. Inflation readings softened over the period, though the results were clouded by shutdown-related distortions. Labor market data sent mixed signals as unemployment edged higher even as job growth remained uneven. Toward the end of the quarter, GDP growth surprised to the upside, highlighting the continued resilience of the economy. The Federal Reserve cut rates twice during the quarter but tempered expectations for future moves, flattening the projected policy path and underscoring the lack of consensus around how restrictive policy remains.

For much of 2025, our strategy focused on taking advantage of a favorable yield and curve environment by shifting from shorter-term structures into longer maturities with better prospects from carry, yield, and roll. Those trades paid off in the third and fourth quarters, particularly as intermediate yields declined and the belly of the curve flattened substantially. Following the fall rally, we were comfortable with our duration and curve exposure and shifted our focus away from further positioning changes. With new issue supply continuing at a record pace, our attention turned to exploiting relative value in the primary market, including an outsized number of “mega-deals” over $1 billion that required steep concessions to clear the market. In that environment, we were being well compensated to provide liquidity. We sold tighter-trading bonds and redeployed proceeds into these new issues, with the expectation that spreads would tighten back to normal as the market absorbed the excess supply.

The municipal bond market enters 2026 with many of the same crosscurrents that defined the second half of 2025. Supply is expected to remain elevated as issuers continue to address deferred capital needs and higher project costs, while broader rate direction remains in flux. Investors are balancing expectations for further policy easing against lingering questions around growth, inflation, and fiscal policy. Despite those uncertainties, demand for tax-exempt bonds remains well supported by attractive tax-equivalent yields and solid trailing performance, a combination that usually provides a powerful tailwind in a retail-driven asset class. Credit conditions also remain constructive, even as revenue growth normalizes from the unusually strong post-pandemic period. Taken together, a shifting rate environment, heavy supply, and solid underlying fundamentals should continue to create opportunities for active managers to add value through security selection and relative value trading in the year ahead.