Munis steady, poised to 'deliver' next year

Munis were steady Friday as U.S. Treasuries were narrowly mixed and equities ended down slightly.

The two-year muni-UST ratio Thursday was at 69%, the five-year at 66%, the 10-year at 67% and the 30-year at 88%, according to Municipal Market Data's 3 p.m. EDT read. ICE Data Services had the two-year at 69%, the five-year at 64%, the 10-year at 67% and the 30-year at 88% at a 4 p.m. read.

The muni bond market stands at an "inflection point," said Nuveen strategists in a 2026 market outlook.

"Following an extended period of underperformance relative to other fixed-income segments, we think municipals are positioned to deliver in 2026," they said.

Multiple tailwinds are coming together to create "a favorable environment" for munis, Nuveen strategists said, noting that while headwinds continue, "disciplined credit analysis and active management can unlock compelling tax-advantaged, risk-adjusted returns for municipal bond investors."

The Federal Reserve's easing cycle should "accelerate the migration of cash into other safe asset classes that offer higher yields," Nuveen strategists said.

Around $7.5 trillion in cash sits on the sidelines waiting to return to fixed-income markets, they noted.

"Investors in the 24% tax bracket now face after-tax yields below 3% on one- to three-month T-bills for the first time since 2022 ? a threshold that should spark meaningful portfolio repositioning," Nuveen strategists said.

Munis are set to benefit from this "great rotation," they said, as the asset class offers "relatively safe, high-quality investments with an average credit rating of AA/Aa2, and current yields are near the most attractive levels of the past decade."

Nuveen strategists expect spreads to compress amidst fund inflows and stable credit conditions, sustaining bond prices.

Over the past decade, positive flows into munis have coincided with positive returns 79% of the time, and Nuveen strategists expect this dynamic to continue in 2026, driving performance.

The asset class should be "relatively insulated from federal fiscal deficits weighing on the long end of the curve, they said.

Most issuers must pass balanced budgets, and budget gaps can be addressed through taxation, Nuveen strategists said.

Market conditions will impact muni-UST ratios, though they expect "short ratios will hover in the 65%?70% range to align with federal tax rates, whereas longer bond ratios will be closer to 90%, which provides even more substantial after-tax yield for investors."

Issuance will remain elevated next year, with Nuveen strategists forecasting $600 billion in anticipated supply, driven by ongoing infrastructure needs and project cost inflation.

Concurrently, principal redemptions and coupon payments are expected to rise 50%, most likely creating "powerful reinvestment flows" from higher prior-year issuance and refinancing opportunities as rates decline, they said.

The $4.3 trillion muni market continues to expand, though "supply composition" varies by sector, according to Nuveen strategists.

"We expect greater volumes of high-quality local infrastructure projects will be funded through municipal bonds at attractive yields driven by elevated supply," they said. "Given our forecast of declining short taxable rates, investors may rotate from cash and lower-yielding investments into new issue municipal bonds offering higher after-tax yields."

Fund flows
Investors added $863.8 million to municipal bond mutual funds in the week ended Wednesday, following $218.3 million of inflows the prior week, according to LSEG Lipper data.

High-yield funds saw outflows of $267.4 million compared to inflows of $16.8 million the previous week.

The SIFMA Swap Index was at 3.32% on Wednesday compared to the previous week's 3.26%.

AAA scales
MMD's scale was unchanged: 2.46% in 2026 and 2.41% in 2027. The five-year was 2.43%, the 10-year was 2.76% and the 30-year was 4.24% at 3 p.m.

The ICE AAA yield curve was unchanged: 2.45% in 2026 and 2.43% in 2027. The five-year was at 2.40%, the 10-year was at 2.77% and the 30-year was at 4.19% at 4 p.m.

The S&P Global Market Intelligence municipal curve was unchanged: The one-year was at 2.45% in 2025 and 2.42% in 2026. The five-year was at 2.43%, the 10-year was at 2.76% and the 30-year yield was at 4.22% at 3 p.m.

Bloomberg BVAL was unchanged: 2.47% in 2025 and 2.43% in 2026. The five-year at 2.37%, the 10-year at 2.71% and the 30-year at 4.13% at 4 p.m.

Treasuries were narrowly mixed.

The two-year UST was yielding 3.482% (-2), the three-year was at 3.532% (-3), the five-year at 3.697% (-2), the 10-year at 4.132% (flat), the 20-year at 4.769% (+1) and the 30-year at 4.817% (+2) near the close.