Monthly Summary
- Municipals (munis) endured one of the most challenging months and quarters on record as yields rose dramatically across the curve. Munis trailed both Treasuries and corporates for the month.
- Supply continued at a record pace in September, with year-to-date (YTD) issuance surpassing $440 billion, 9% ahead of last year, while tax-loss selling also tested technicals.
- Fundamentals remained supportive. State and local tax collections continued to show strong growth and reached record levels, according to Census data released during the month, reinforcing the broadly constructive credit backdrop for municipals.
Performance Review
- Municipal returns fell sharply in September, pushing the Bloomberg Municipal Bond Index negative for the year.
- The Bloomberg Municipal Bond Index returned -4.36% month-to-date (MTD), marking the worst quarterly return (-6.8%) since 1981; its YTD return was -4.18%. Shorter-duration bonds outperformed most maturities amid the rate volatility as duration risk drove most of the month's losses.
- Lower-rated credit continued to outperform, as the Muni High Yield Index returned -4.31% MTD.
Figure 1: Index Returns
Source: Bloomberg. As of September 30, 2026.
Rates & Duration
- Resilient economic activity, elevated energy prices, and renewed Federal Reserve (Fed) tightening pushed Treasury yields higher across the curve in September. While late-month inflation data offered some relief, tension between monetary and fiscal policy is emerging as a key issue to watch for financial investors. Fed Chair Kevin Warsh has established his hawkish credentials. Franklin Templeton CIO Sonal Desai sees scope for further yield curve steepening and a range of selective opportunities, based on capturing income and focusing on quality rather than counting on lower rates or tighter spreads. Read Desai’s latest On My Mind: One Flew Over the Dove’s Nest.
- The Treasury curve flattened, with yields moving 54-59 basis points (bps) higher within 10-year tenors and 39 bps higher in 30-year tenors. Municipal yields sharply underperformed across the curve, with yields rising 75-87 bps within 10-year tenors and 61 bps higher in the longest maturities.
Figure 2: Municipal AAA vs. US Treasury Yield Curves
Source: Bloomberg. As of September 30, 2026.
Technical Pressur e Contributed to Underperformance
- Issuance continued at a record pace as municipal issuance of $56 billion during the month was 15% higher than September of the prior record-issuance year. YTD new issue supply of $465 billion is tracking 6% ahead of last year’s pace.
- Municipal demand moderated from the elevated levels seen earlier in the year, with approximately $776 million of net inflows reported through month-end, down from $8.3 billion in August, according to estimates from Lipper and the Investment Company Institute. Tax-loss harvesting activity accelerated, with substantial outflows from open-end mutual funds offset by inflows into ETFs.
Figure 3: Municipal Supply
Source: Bloomberg. As of September 30, 2026.
Fundamentals Remain Resilient
- In September, the Census released state and local tax collection estimates for the second quarter of 2026, coinciding with fiscal year-end for many municipalities. Major state and local tax collections totaled an estimated $598 billion, up 6.4% from the second quarter of 2025. Among major state revenue sources, individual income tax collections increased 9.2% year over year, corporate income tax collections rose 10.7%, and sales tax collections increased 4.0%. Property tax collections, the primary revenue source for local governments, grew 3.6%.
- Record tax collections reflect resilient labor markets and healthy tax bases, providing continued support for municipal credit fundamentals. While stronger revenues should improve issuers’ ability to absorb rising costs, conditions vary materially across regions and credits. Our latest installment, Balanced Budgets, Uneven Pressures, reflects on the US fiscal year 2027 budget season and explores the fiscal trends driving increasingly divergent credit outcomes across municipal issuers.
Figure 4: 12-Month Trailing State and Local Revenue Collections
Source: Bloomberg. As of June 30, 2026.
Tax-Exempt Income Opportunities and Relative Valuations Are Compelling
Benchmark municipal yields have now approached 8%-10% on a taxable-equivalent basis, offering a substantial premium over comparable Treasuries at intermediate and longer maturities.
- Municipal-to-Treasury (M/T) ratios stood at 73% at both the 2- and 5-year maturities, 78% at 10-years, and 93% at 30-years as of September 30, 2026, with the long end offering the best relative value on the curve. However, most maturities are now above their three-year average ratios, led by the 30-year at 93% versus an 86% average.
- Investors may be able to use the dislocation to harvest tax losses, rebalance duration, and improve portfolio income. Higher starting yields now offer a better path toward income and after-tax total return objectives without requiring investors to materially extend duration or relax credit standards.
Figure 5: Bloomberg Fixed Income Yields
Source: Bloomberg. As of September 30, 2026.
SOURCES:
Figure 1: Bloomberg Municipal Index, Bloomberg Municipal GO Bond Index, Bloomberg Municipal Revenue Bond Index, Bloomberg AAA, Bloomberg Municipal AAA Index, Bloomberg Municipal AA Index, Bloomberg Municipal A Index, Bloomberg Municipal AA Index, Bloomberg BAA Index, Bloomberg 1-5 Year Blend (1-6) Total Return Index, Bloomberg 1-15 Year Municipal Index, Bloomberg Municipal High Yield Index as of September 30, 2026.
Figure 2: Bloomberg BVAL AAA Muni Curve, Bloomberg US Treasury Actives Curve. As of September 30, 2026.
Figure 3: Bloomberg Municipal Supply. As of September 30, 2026.
Figure 4: Bloomberg 12-month trailing state and local revenue collections. As of June 30, 2026.
Figure 5: Bloomberg fixed income yields. As of September 30, 2026.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Fixed income securities involve interest rate, credit, inflation, and reinvestment risks, as well as possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity, and the possibility of default. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer, or guarantor, may affect the bond’s value. Derivative instruments can be illiquid, may disproportionately increase losses, and have a potentially large impact on performance. An investor may be subject to the federal alternative minimum tax, and state and local taxes may apply. Diversification does not guarantee a profit or protect against a loss.