What September’s Selloff Means for Your Municipal Bond Portfolio
The Signal
The fourth quarter opened where September left off. The 10-year Treasury briefly touched 5.34% this morning, its highest level since 2002, before settling near 5.32%, and the 30-year reached 5.67%, a 24-year high. The trigger was the ISM Prices Paid index, which came in at 77.9 against 73.0 expected, a reminder that inflation pressure has not gone away. The long end continues to take the brunt of the selling.
September made that plain. Treasuries had their worst month in nearly two years, investment grade corporates lost 2.72%, their worst month in more than three years, and the Bloomberg Municipal Index finished the month down 4.36%.
Last week, we said buyers were treating higher yields as an opportunity rather than a reason to wait, and that we would keep watching whether the Fed’s tone turned into action. This week tested both. Yields pushed higher still and the Fed’s message did not soften, yet buyers showed up again.
What’s Driving It
Inflation Data Keeps the Fed on the Offensive
Markets are now pricing in four rate hikes by June 2027. Minneapolis Fed President Neel Kashkari said this morning that he does not know how high rates need to go, and Kansas City Fed President Jeff Schmid said the Fed still has work to do on inflation. The labor data is not giving policymakers a reason to back off either: jobless claims dropped to 197,000, the lowest since July. Ten Fed speakers are on the calendar today, and the September jobs report arrives tomorrow morning.
Buyers Step In as Value Improves
After a rough September, munis rallied sharply, with the 10-year AAA yield falling almost 11 basis points to 4.13%, the biggest one-day drop since April 2025. Buyers are clearly stepping in. Vanguard’s Tax-Exempt Bond ETF (VTEB) took in a record $1.4 billion in a single day on Wednesday, and $4.6 billion for the month of September.
Relative value is as attractive as it has been all year. The 10-year muni to Treasury ratio is near 78% and the 30-year is near 93%. For investors in the top federal bracket, that translates to tax-equivalent yields above 7%.
Credit Is Solid, but Selectivity Matters
Upgrades outpaced downgrades last week, $34.2 billion to $3.2 billion. That said, school districts, higher education, and healthcare have seen more downgrades this year, and charter schools are leading defaults. Overall strength is not a substitute for credit-by-credit work.
Supply Stays Heavy, While Some Issuers Wait
Closer to home, Mountain Peak Special Utility District here in Texas pushed its $46.6 million revenue bond sale back a couple of weeks to wait out the volatility. Overall supply remains strong, with $460.5 billion issued through September, up 7.6% from last year.
Our Take – Sloppy Markets
September tested everyone’s patience, and we will not pretend otherwise. A 4.36% decline in the municipal index is a real loss for anyone who held through it. But this is the kind of market where opportunities tend to show up.
High-quality munis with coupons of 5% or more, and tax-equivalent yields above 7% for top-bracket investors, have not been available in a long time. We do not need to call the bottom to see that. Our approach is to step in gradually, stay with high quality, and let the data set the pace.
A hot inflation print, a strong jobs report, or a Fed that keeps leaning toward more hikes could push yields higher before they settle, and the long end has shown how quickly it can move. Tomorrow’s jobs report and today’s Fed speakers are where we will look first for direction. We are watching closely and will keep you posted.
Recommendations
Build positions gradually rather than all at once
With the 10-year AAA muni yield at 4.13% and tax-equivalent yields above 7% for top-bracket investors, there is income on offer that has been scarce for years. Volatility may continue, so we favor adding in stages rather than trying to pick a single entry point.
Stay with high quality, and be selective where credit is under stress
Upgrades are outpacing downgrades overall, but school districts, higher education, and healthcare have seen more downgrades this year, and charter schools are leading defaults. We continue to favor high-grade credits and would welcome a review of any exposure you hold in those sectors.
Let tomorrow's jobs report and today's Fed speakers guide the pace
Both may shape rate expectations in the near term. We are approaching portfolios with the possibility of further tightening in mind, rather than assuming the worst of the selloff is behind us.
Take advantage of a steady supply of new paper
Issuance has reached $460.5 billion through September, up 7.6% from last year, which gives us a wide field to choose from even as some issuers wait out the volatility. With the 30-year muni to Treasury ratio near 93%, the long end deserves a look for clients with a long horizon. 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.
