Inside This Week’s Strong Demand for Municipal Bonds
The Signal
Municipal bonds traded down in price this week, pushing yields on benchmark securities to their highest levels since at least 2011. The 10-year AAA municipal benchmark rose to 3.87%, and the 30-year climbed to 4.96%, levels not seen since January and February of 2011, respectively. Treasuries moved the same way, with yields on the government’s longest-dated bonds reaching their highest point in more than two decades.
The more telling story is what is happening on the other side of that move. Capital is flowing into individual bonds and municipal ETFs alike, as buyers lock in yields not available for a long time. Appetite is strong across the curve, particularly beyond ten years, where investors appear comfortable extending duration to capture these levels.
Two weeks ago, we told you the odds had shifted from unlikely to more likely that the Fed would hike at its September 16 meeting. That hike came, a unanimous quarter-point move to 3.75%-4%, the Fed’s first increase since 2023. This week’s market is the aftermath, yields higher, demand stronger, and the question no longer whether the Fed would act, but what it does next.
What’s Driving It
Yields Climb on Inflation, Fiscal, and Geopolitical Pressure
The selloff behind these yield levels has been fueled by inflation and fiscal concerns, compounded by the ongoing Iran conflict and rising oil prices, with many investors now positioning for another hike as the Fed’s next meeting approaches. Demand has held up despite, or perhaps because of, the higher yields on offer. A Texas water bond priced September 23 was oversubscribed on maturities beyond 15 years, with yields of 4.75% and higher, evidence that buyers see current levels as opportunity rather than a reason to wait.
Record Inflows Confirm the Demand Story
The two largest municipal bond ETFs logged their biggest-ever weekly inflows last week, on the heels of outflows tied to the broader fixed-income selloff. The $46 billion iShares National Muni Bond ETF took in about $1.2 billion, and the $47 billion Vanguard Tax-Exempt Bond Index ETF added a net $1.7 billion, per Bloomberg data. With long-end muni yields touching 5%, that level of interest does not surprise us. Nathan Will, Vanguard’s head of municipal credit research, points to the yield environment as the driver: tax-equivalent yields are hard to match elsewhere in fixed income, and muni valuations have grown more attractive relative to taxable bonds. We agree. On a taxable-equivalent basis, the relative safety and liquidity of this asset class is hard to pass up.
Fed Officials Signal the Work May Not Be Done
Richmond Fed President Tom Barkin said last week’s hike should help slow inflation, though he stopped short of signaling whether more tightening is needed, cautioning that supply shocks are no longer proving temporary. Fed Governor Michael Barr went further, saying additional rate increases are likely needed to return inflation to the 2% target. Chicago Fed President Austan Goolsbee echoed the concern, warning that persistent supply shocks may require a response even if it causes economic hardship. That tone is showing up in new issuance: supply has tapered, but the paper coming to market is being priced aggressively to move, adding further upward pressure on yields.
A Credit Note Worth Watching: New Haven, Connecticut
Moody’s affirmed its Baa1 rating on New Haven, Connecticut but revised the outlook to stable, citing an expectation that improvements to reserves and liquidity will come more gradually than previously anticipated as the city works to restore structural balance. New Haven has about $695 million of debt outstanding. If you hold this paper, we would welcome a conversation about it.
Our Take – Sloppy Markets
The headline is that yields have climbed and continue to move up, but the more useful story is how the market is responding. Demand has not backed away from higher rates, it has leaned into them, and record ETF inflows alongside an oversubscribed Texas deal tell us buyers view this repricing as opportunity, not a signal to wait.
We are watching three things: whether the Fed’s hawkish chorus becomes action at the next meeting or proves to be posturing ahead of it, whether new issuance stays light enough that aggressive deal pricing keeps supporting secondary yields, and how New Haven and similar credit-specific situations develop as issuers work through longer runways to structural balance.
September has been a rough month for anyone holding bonds through this repricing, and we will not pretend otherwise. But for clients with a long-term outlook, a market offering you yields like these is working in your favor. New issuance is already slowing as borrowing costs rise, and it would not surprise us if the Treasury revisits a buyback program at these levels. We are watching closely and will keep you posted.
Recommendations
Use this repricing to lock in longer-term yields
With 10-year and 30-year municipal benchmarks at their highest levels since at least 2011, clients with a long-term horizon have an opportunity to secure income levels not available in years. This is not a call to abandon discipline, it is a case for acting on it.
Favor higher-grade paper as new issuance gets priced aggressively
Deals are coming to market fewer in number but priced to move, pulling secondary yields higher alongside them. We continue to favor high-grade credits that can absorb that pressure without adding unnecessary risk.
Watch the Fed's next move, not just its last one
Barkin, Barr, and Goolsbee have each suggested the central bank’s inflation work may not be finished. We are approaching portfolios with further tightening in mind rather than assuming last week’s hike was the last word.
If you hold New Haven, Connecticut paper, let's talk
Moody’s stable outlook is a reasonable near-term signal, but the city’s longer runway to structural balance is worth discussing in the context of your broader municipal allocation. Reach out if you would like to discuss any of this in the context of your portfolio.
Let’s Talk
If you would like to discuss any of the above in the context of your portfolio, reach out. This market environment rewards preparation — and that is exactly what we are here to help with.
