Absolute muni yields are attractive within volatile rate environment

Key Takeaways

• After touching their lowest levels since October 2024 at the start of the Iran War, investment grade municipal (muni) bond yields are once again flirting with their highest levels since mid-2025.
• Although relative valuations to U.S. Treasuries appear rich, today’s muni yields create a sturdy performance foundation for long-term muni investors, particularly after adjusting for their favorable tax treatment.
• Munis remain sensitive to Iran-related developments that are driving U.S. Treasury yields and raising overall rate volatility, but muni demand is set to accelerate through the summer months.

What happened

In March, U.S. Treasury yields, which provide powerful directional leadership for munis, rose sharply as traders grew worried about the inflationary impact of rising oil prices and the threat of a prolonged conflict with Iran. Also, munis entered a typically weak period of buyer demand. In general, March usually marks one of the lightest months for reinvestment activity (i.e., investors roll maturing securities into new muni purchases) of the calendar year. Lastly, municipalities are on pace to issue the largest volume of new muni debt on record. As a result of these factors, munis posted one of their worst months of performance since late 2023 but also reset to higher absolute yields.

In April, the overall rate backdrop stabilized as the U.S. and Iran announced a tenuous ceasefire and optimism grew that the Strait of Hormuz could reopen. Still, ongoing geopolitical and inflation uncertainty leave absolute muni yields well above their pre-conflict lows.

Munis are entering a more favorable seasonal period

Moving forward, muni demand is poised to accelerate and remain robust through the summer. The $195 billion of munis scheduled to mature between now and August should create a formidable engine of muni demand. We do expect muni issuance to maintain a feverish pace. Massive public projects delayed by the pandemic continue to come online. Also, state and local governments have exhausted COVID-era federal aid, creating a need for debt financing. However, reinvestment activity and elevated starting yields should help participants digest the burgeoning supply.

Muni yields will remain very sensitive to moves in the U.S. Treasury market. A durable resolution in Iran would likely help lower the overall interest rate environment, translating to lower muni yields and positive price appreciation. On the flip side, a protracted stalemate in the Strait of Hormuz or military re-escalation in the Middle East would likely lift yields, though our work suggests rising yields would ultimately be met with invigorated demand and limit how far U.S. yields could rise on a sustainable basis.  

Elevated muni yields provide cushion against rising rates

Historically, more than 80% of long-term fixed income returns are attributable to their income generation. Currently, the Bloomberg Municipal Bond Index’s yield to worst is 3.7%, which equates to a taxable-equivalent yield near 6% (assuming a 37% federal tax bracket). Before the peak in late March, that is the highest level since September 2025. From this starting point, muni yields could rise more than 50 basis points (0.50%) over the next 12 months, and the index would still generate a positive total return. Additionally, accounting for their favorable tax treatment, municipal bonds continue to offer relative value over like-rated corporate bonds beyond 10-year maturities.

Bottom line

Elevated starting yields, improved relative valuations, stable credit fundamentals, and abating seasonal challenges suggest investment grade munis offer an attractive entry point for new investments. Muni yields will remain sensitive to fluctuations in the U.S. Treasury market, though a durable resolution with Iran would likely ease oil prices and create downward pressure on municipal bond yields.