This month’s Muni Monthly covers performance, supply and demand technicals, fundamentals and valuations for the month ending August 2026.
Performance Overview: Long-end municipals underperformed in August.
Market volatility persisted in August as investors were again forced to reassess escalating tensions and an exchange of military strikes in the Middle East, while softer labor-market data was countered by mixed inflation readings. Total nonfarm payroll jobs declined by 23,000 in July and headline Consumer Price Index (CPI) eased modestly to 3.4% from 3.5% year-over-year, while core Personal Consumption Expenditures (PCE) remained unchanged at 3.3%. Against this backdrop, the Treasury curve flattened, with yields rising approximately 5 basis points (bps) in shorter maturities and declining approximately 3 bps in longer maturities.
Municipals posted negative returns in August, underperforming taxable investment-grade fixed-income sectors, which largely posted positive returns (the Bloomberg Municipal Index returned -0.23% for the month, while the U.S. Aggregate Index returned 0.39%). Municipal underperformance was largely driven by curve steepening, which contrasted with the flattening observed in taxable markets and weighed on returns in the longest maturities, amid elevated rate volatility and a continued record pace of issuance.
Exhibit 1: Monthly Bloomberg Municipal Bond Index Total Returns
Source: Bloomberg, Western Asset. As of 31 Aug 26.
Technicals: Elevated issuance in August continued a record trend.
Municipal technicals remained dominated by record supply levels. Total municipal issuance reached $63 billion in August, up 30% from July and 35% above the 10-year average. Meanwhile, fund flows continued to reflect steady demand for municipal securities. According to Lipper, municipal funds recorded $8.4 billion of inflows, bringing year-to-date (YTD) net inflows to $77 billion, well above the $60 billion recorded for the full 2025 calendar year. The current inflow cycle began in December 2023 and has generated approximately $181 billion of net inflows, now the second-largest cycle by cumulative flows, only $3 billion below the post-pandemic record ($184 billion), and the second-longest by duration (141 weeks), according to ICI and Lipper data.
Exhibit 2: August Tax-Exempt Supply Continued Record Pace
Source: Western Asset, Lipper, ICI. As of 31 Aug 26.
Fundamentals: Strong credit fundamentals drive continued rating upgrades across the municipal market.
Strong municipal credit fundamentals continued to support rating upgrades across the market. Moody’s upgraded the State of Illinois’ general obligation bonds by one notch, from A2 to A1, and maintained a stable outlook. The agency also upgraded Illinois sales tax bonds and Metropolitan Pier and Exposition Authority bonds. These actions mark the 14th consecutive positive rating action by Moody’s, S&P or Fitch since the pandemic-related market disruption in April 2020, when Illinois carried ratings equivalent to BBB− across the three agencies, with negative outlooks or watches.
Despite Illinois’ outperformance and the substantial spread compression since 2020, the market continues to price a modest concession relative to similarly rated municipal securities. This may present opportunities for investors who believe the state’s positive credit trajectory can continue. However, with much of the credit improvement now reflected in valuations, we believe generating further outperformance in this tighter-spread environment will require increasingly rigorous credit analysis and security selection.
Exhibit 3: Illinois Spreads Tightened With Upgrades
Source: 30Y Illinois Spread (Bloomberg 30Y Illinois BVAL Curve − 30Y AAA Callable Curve); 30Y A Spread (US General Obligation A+/A/A− Muni BVAL Yield Curve − 30Y AAA Callable Curve). As of 27 Aug 26.
Valuations: Muni bond weakness enhances tax-exempt income opportunities.
Municipal underperformance in August has improved tax-exempt income opportunities and relative value. The Bloomberg Municipal Bond Index yield-to-worst rose to a YTD high of 3.98%, equivalent to 6.72% on a taxable-equivalent basis for investors subject to the highest marginal tax rate. That compares with the 4.61% yield of the Bloomberg U.S. Treasury Index and 5.49% of the Bloomberg Corporate Index. After-tax yield advantages across maturities and credit-quality cohorts remain above their five-year averages, supporting more attractive entry points for the municipal asset class amid broader market volatility.
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.
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