Key Takeaways
- Municipal bonds have meaningfully underperformed taxable bonds, and the curve move for the year to date in munis explains a lot of this.
- Two factors have likely contributed to this yield move: elevated supply chain and elevated volatility.
- Fundamentals remain pretty robust, so the muni market is in a good spot to handle economic volatility.
- When assessing severe weather-related risks to the muni-bond market, focus on analyzing individual credit profiles and think about valuation: Are you getting paid enough to take that credit risk?
- Ongoing and continued volatility allows active investors to take advantage of opportunities and add bonds to the portfolio that offer strong risk-adjusted returns moving forward.
Elizabeth Foos: Hi, I’m Beth Foos with Morningstar. Severe weather events, along with debates regarding the budget and even the future of the tax-exempt status, have added new layers of complexity to the municipal-bond market in recent months.
Munis have been quite volatile in the first half of 2025, and for investors, being able to navigate these choppy markets is more important than ever. Today, I’m speaking with an experienced portfolio manager, Capital Group’s Courtney Wolf, to understand how to do just that.
Courtney, thank you so much for being here with me today.
Courtney Wolf: Beth, delighted to be here. Always fun to speak with you.
How Market Volatility Created Opportunities for Muni Investors
Foos: Absolutely, thanks. The municipal-bond market, as I mentioned, in the first half of 2025 was pretty volatile. So, while taxable bonds were up, most muni-bond categories were down through the end of May. Help us understand what contributed to that trend and what’s created an investment opportunity for muni investors.
Wolf: It has been a really interesting first half of the year, and I really like the setup heading up into the back half of the year. As you mentioned, munis have meaningfully underperformed taxables. If you look at a broad-based investment-grade muni-bond index, it’s down about a percent year to date. If you look at that investment-grade taxable US bond index, so if you think about the US Agg [Bloomberg US Aggregate Bond Index], it’s up about 3% year to date. So, there’s been a 400-basis-point delta in total returns for munis versus taxables.
I think the curve move year to date in munis explains a lot of this. We’ve seen yields for investment-grade long bonds rise pretty meaningfully year to date. If you look at muni 20- to 30-year investment-grade bonds, the yields have risen 50 to 70 basis points over the last five to six months. If you look at the Treasury market, yields are only up about 10 basis points. So, the long end of the muni market has really been impacted and driven sort of negative total returns.
There are a few things that have likely contributed to this yield move. I’d say two factors come to mind. The first is that supply has been elevated. If you think about new-issue supply, year to date, it’s up about 20% versus last year or up about 50% versus the last five years. So, pretty meaningful supply in our market and higher yields have been required to get investors to come in, and sort of demand meets supply.
I think the second factor is just elevated volatility. You mentioned it, the macro backdrop is uncertain. We’ve had a lot of rate volatility, and the muni market tends to not love uncertainty and volatility. The muni market’s been a bit weaker from that standpoint.
If you think about the setup moving forward, again, I’m pretty constructive, and I should note that these are my own views as a portfolio manager, not the Capital views, but my own views. I think it’s really interesting for two reasons. The first is overall yields are elevated. So, if you think about long, high-grade municipal bonds, the yield on that is often about 4.75% right now. That’s pretty high relative to history.
Then the second thing is I think munis look really interesting to taxable alternatives for those who pay taxes. If you think about that high-grade muni-bond index yielding about 4.00%, if you tax-adjust that for those who are in the highest income tax bracket, you get to a 6.75% taxable equivalent yield. That’s a lot of extra yield pickup versus, let’s say, the US Agg at about a 4.60% today. I think the relative value of munis is pretty compelling.
Then the final thing I note is that fundamentals remain pretty robust. So, the muni market’s in a good spot to handle economic volatility, in my opinion.
Will Current Fiscal Policy and Potential Tax Law Changes Affect the Muni Market?
Foos: And that kind of leads me to my next question, so super interesting. But how might some of the current fiscal policy debates and potential tax law changes impact the muni market moving forward? I know you talked a little bit about that, but if you could dive a little deeper into that, it would be helpful.
Wolf: The tax bill really hasn’t been finalized. I’d say nothing I’m currently hearing out of Washington or in those discussions worries me with respect to the value of municipal bonds. When I think about building portfolios, I really focus on three key pillars: fundamentals, valuations, and technicals. And the fiscal policy can certainly impact some of those pillars, but again, we’re keeping a close eye on it, but nothing that I’m hearing out of Washington today meaningfully impacts my view on those three pillars, and as a result, my portfolio construction process at this point.
How Investors Can Account for the Impact of Severe Weather Events on the Muni-Bond Market
Foos: Shifting gears a little bit, we started the year with devastating wildfires in the Los Angeles area. I know that’s where you’re located. And we just started hurricane season in the Atlantic. So, maybe talk a little bit about how impactful are severe weather events in the muni-bond market? And are investors accurately pricing that risk in?
Wolf: It’s a question that we’re getting a lot from clients. It obviously hits home for me. What I would say is our analysts are really focused on analyzing individual credit profiles from the bottom up and helping us navigate some of these risks or events, which seem to be happening with more frequency. But it is one of many considerations they have when thinking about credit profiles. Again, analysts here at Capital analyze credits one by one, and they have a lot of different considerations when they’re thinking about assessing the credit profile.
Then the next step is to think about the valuation. Are you getting paid enough to take that credit risk? And in some cases, they would say, “Maybe not,” and that could be driven by environmental factors, but it’s likely a variety of different factors. Then in many cases, they’ll say, “Yes, you’re getting paid enough to take that credit risk.” So, I would say generally speaking, it’s hard to make broad statements about regions or particular sectors that we’re avoiding at this point. I think our analysts do a great job incorporating these environmental and natural disaster risks into their assessment of the relative value of each individual CUSIP.
How Continued Market Volatility Can Benefit the Muni and Bond Markets in 2025
Foos: That’s super helpful, thanks. I know we’ve covered a lot already, but what other topics are your research team focused on as we enter the second half of 2025?
Wolf: Beth, I would say for me, what I hear a lot is we expect volatility to continue. While that may sound scary, I think that’s really exciting for active investors because it gives us the ability to generate excess return and deliver a strong pattern of results for clients and shareholders. So, we use volatility to try to buy bonds that we think are really interesting and will deliver strong excess returns and strong returns for clients over time.
When you think about the Capital system, we have analysts as investors, and a long time horizon. We have a dedicated team of traders. That process and those resources married with the muni market, which, as you know, has almost a million CUSIPs, thousands and thousands of issuers, I think really lends itself to active management.
So, I’m super excited about the prospect of ongoing and continued volatility as I think it allows us to, again, take advantage of those opportunities and put bonds into the portfolio that we think offer strong risk-adjusted returns moving forward.
Foos: Well, Courtney, thanks so much for joining me today. There’s always an interesting topic to discuss in the muni market, and you’ve really given us a lot to think about. I really appreciate your time.
Wolf: Thanks so much, Beth. Great to be here.