This month’s Muni Monthly covers performance, supply and demand technicals, fundamentals and valuations for the month ending December 2025.
Performance Overview: Munis posted below average returns in December.
Municipal bonds posted positive returns in December, as reflected by the Bloomberg Municipal Bond Index’s total return of 0.09%. That is below the prior 10-year average December return of 0.57% as Treasury rates moved higher during the month amid an uptick in hawkish language from the Federal Reserve. Municipals outperformed Treasuries and corporate bonds, which returned -0.33% and -0.20%, respectively, amid improved technicals during the month.
Exhibit 1: December Total Return by Year
Source: Bloomberg, Western Asset. As of 31 Dec 25.
Supply and Demand Technicals: The tax-exempt muni supply maintained an elevated pace, as observed throughout the year.
The month of December showed a strong supply and demand technical backdrop, which was a key contributor to municipals’ outperformance. New-issue volume remained robust and concluded the record year of issuance. Total December new-issue volume reached $40 billion, down 12% from November levels, but up 25%from December 2024. Through 2025, municipalities issued a record $588 billion of new issuance, up from $500 billion during the prior record year.
From the demand perspective, investor flows accelerated into the end of the year. Lipper reported $5.9 billion of inflows into municipal funds, 60% higher compared to November’s $3.7 billion. Demand continued to concentrate in longer-maturity funds, with the long-term category attracting $3.0 billion of inflows.
Fundamentals: Improved credit trends were reflected in ratings activity in December.
Municipal credit fundamentals continued to show resilience despite slowing growth trends. Census-reported 2Q25 state and local tax collection estimates, which capture fiscal year-end results for most governments, showed 12-month trailing collections increased 4% year-over-year (YoY) to $2.1 trillion, a record high. Twelve-month trailing individual income tax collections rose 8% YoY, sales tax collections increased 2% YoY while corporate income tax collections were relatively flat. Rolling 12-month property tax collections, the primary revenue source for local governments, increased 2% YoY.
The improved credit trends were reflected in ratings activity. Public rating agency upgrades outpaced downgrades by more than 2 to 1, according to Bloomberg. Muni default activity also remained limited and largely isolated to select high-yield sectors and issuers. Through December 15, 2025, the muni market recorded 51 first-time payment defaults totaling $1.5 billion, down from 60 defaults totaling $2.1 billion in 2024, according to Bloomberg.
Exhibit 2: 2025 Muni Defaults by Sector (% Par Value)
Source: Bloomberg. As of 15 Dec 25.
Valuations: Municipals generally offered higher after-tax yield advantages than at the start of the year.
Relative underperformance and record supply conditions improved the tax-efficient income opportunities offered by munis entering 2026. The average investment-grade municipal yield, as measured by the Bloomberg Municipal Bond Index, ended the year just 14 bps lower at 3.60%. By comparison, yields on the Bloomberg Treasury Index and Bloomberg Corporate Index declined by 56 bps and 52 bps, respectively. Given the smaller magnitude of the municipal yield decline, after-tax relative valuations improved across most segments of the curve and credit structures over the year.
Exhibit 3: Muni vs. Taxable After-Tax Yield Pickup--YoY Change (bps)
Source: Bloomberg, Western Asset. As of 02 Jan 26. 10- and 30-Year comparison reflects Bloomberg Valuation Service (BVAL) AAA Muni Curve and US On-/Off-the-Run Sovereign Curve. AA Muni reflects the Bloomberg AA Muni Bond Index. A Muni reflects the Bloomberg A Muni Bond Index. BBB Muni reflects the Bloomberg BBB Muni Bond Index. HY Muni reflects the Bloomberg High Yield Muni Bond Index. AA Corp reflects the Bloomberg AA Corporate Bond Index. A Corp reflects the Bloomberg A Corporate Bond Index. BBB Corp reflects the Bloomberg BBB Corporate Bond Index. After-tax yield considers top marginal tax rate of 40.8%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future preformance.
Definitions:
“AAA” and “AA” (high credit quality) and “A” and “BBB” (medium credit quality) are considered investment grade. Credit ratings for bonds below these designations (“BB,” “B,” “CCC,” etc.) are considered low credit quality, and are commonly referred to as “junk bonds.”
One basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).
The Bloomberg Municipal “Muni” Bond Index covers the USD denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and prerefunded bonds.
The Bloomberg Municipal High Yield Bond Index is an unmanaged index made up of bonds that are non-investment grade, unrated, or rated below Ba1 by Moody’s Investors Service with a remaining maturity of at least one year.
The Bloomberg Taxable Municipal Bond Index is a rules-based, market-value-weighted index engineered for the long-term taxable bond market. To be included in the index, bonds must be rated investment-grade (Baa3/BBB- or higher) by at least two of the following ratings agencies if all three rate the bond: Moody’s, S&P, Fitch. If only two of the three agencies rate the security, the lower rating is used to determine index eligibility. If only one of the three agencies rates a security, the rating must be investment-grade.
The Bloomberg US Corporate Bond Index measures the performance of the investment-grade, fixed-rate, taxable corporate bond market. It includes U.S. dollar-denominated securities publicly issued by US and non-US industrial, utility and financial issuers.
The Bloomberg US Treasury Index measures the performance of US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with at least one year until final maturity. Treasuries, if held to maturity, offer a fixed rate of return and a fixed principal value; their interest payments and principal are guaranteed.
The Bloomberg Valuation Service (BVAL) provides prices on a daily basis for over 2.5 million securities across all asset classes.
The Bloomberg AAA BVAL Callable Municipal Credit Curve is represented by the US General Obligation AAA Muni BVAL Yield Curve. The BVAL curve is populated with pricing from uninsured AAA General Obligation bonds. The curve is populated with high quality US municipal bonds with an average rating of AAA from Moody’s and S&P. The yield curve is built using non-parametric fit of market data obtained from the Municipal Securities Rulemaking Board, new issues, and other proprietary contributed prices. The curve represents 5% couponing. The 3-month to 10-year points are bullet yields, and the 11-year to 30-year points are yields to worst for a 10-year call.
The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.
Inverted yield curve refers to a market condition when yields for longer-maturity bonds have yields which are lower than shorter-maturity issues.
Yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and 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 possibility of default.
Municipal income may be subject to state and local taxes. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.
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.
U.S. Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the US government. The US government guarantees the principal and interest payments on US Treasuries when the securities are held to maturity. Unlike US Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the US government. Even when the US government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
WF: 8271709
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