Bond markets quiet as FOMC meeting minutes released

Munis were steady Tuesday as U.S. Treasuries were little changed and equities ended down.

The two-year muni-UST ratio Tuesday was at 70%, 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 65%, the 10-year at 67% and the 30-year at 87% at a 4 p.m. read.

At the beginning of the year, munis hit a "bump," said Capital Group strategists.

"The typically steady fixed income sector delivered positive results but notably lagged its taxable counterparts, creating one of the most unusual environments in recent memory," they said.

Despite a second-half rally in long-dated munis, which suggests a recovery, "returns through November for the Bloomberg Municipal Bond Index still trailed the Bloomberg U.S. Aggregate Bond Index by over 3%," they said.

This ? which is one of the biggest benchmark deviations in years ? offers a "compelling opportunity" for investors seeking tax-efficient income, Capital Group strategists said.

This divergence occurred in part due to several technical and structural factors, they said.

Early in 2025, supply surged over 16% compared to the same period last year as issuers accelerated deals and dealt with rising project costs, they said.

"Lower prices were needed to clear that supply, leading to weaker total returns than comparable taxable bonds," Capital Group strategists said.

Perceived political risk ? including fears of the potential elimination of the tax exemption and uncertainty surrounding the impact of tariffs and their volatility-induced effects ? contributed to the divergence, they said.

These, among other elements, have led to a muni curve that is around twice as steep as the Treasury curve.

"This underscores the valuation gap and signals potential for a catch-up phase," Capital Group strategists said, noting such wide gaps historically have often "preceded strong results as fundamentals reassert themselves."

During the second half of the year, the muni market provided "some green shoots," they said.

Issuance in October posted the second-best month of the year at $58.384 billion, according to LSEG.

Volume was at $535.15 billion through November, up 11.5% year-over-year, according to LSEG. This officially topped 2024's record $507.585 billion volume.

"This uptick in supply was met with more robust demand, as muni fund flows remained positive for the month, totaling about $56 billion through November year-to-date, amounting to $7.6 billion more than the same period in 2024," Capital Group strategists said.

Manageable supply and positive fund flows "helped absorb new issuance and supported the market's ongoing normalization," they said.

"Investor interest was driven by waning political risk, elevated absolute yields and anticipation of further rate cuts amid moderate supply," Capital Group strategists said.

This momentum in fund flows, along with the technical backdrop, "reinforces the case for munis to potentially outpace taxable fixed income sectors in the months ahead," they said.

"Seasonal demand and reinvestment flows are expected to exceed new issuance in the second half of the year ? potentially accelerating normalization," Capital Group strategists said.

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 little changed: 2.45% (unch) in 2026 and 2.40% (-1) in 2027. The five-year was at 2.37% (-1), the 10-year was at 2.76% (unch) and the 30-year was at 4.18% (unch) at 4 p.m.

The S&P Global Market Intelligence municipal curve was unchanged: The one-year was at 2.44% in 2025 and 2.41% 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 2.42% 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 little changed.

The two-year UST was yielding 3.449% (-1), the three-year was at 3.501% (flat), the five-year at 3.679% (+1), the 10-year at 4.127% (+2), the 20-year at 4.757% (+1) and the 30-year at 4.81% (+1) near the close.

FOMC meeting minutes
The Federal Open Market Committee meeting minutes showed the decision was closer than the vote indicated, with "a few" voters suggesting they would have supported no change at the meeting.

Still, the release noted the panel expects to lower rates further if inflation eases, as expected.

"A few of those who supported lowering the policy rate at this meeting indicated that the decision was finely balanced or that they could have supported keeping the target range unchanged," according to the minutes.

The divide on the panel was between those believing a cut was needed to help the labor market, while others worried about "higher inflation becoming entrenched" and cuts when inflation remains above target could be seen as abandonment of the 2% inflation target.

The minutes "suggested officials remain divided on the path forward," said Priscilla Thiagamoorthy, senior economist at BMO. "There's a high degree of uncertainty heading into next year, with key policymaker changes, including a new chair. We continue to expect three 25-bp rate cuts through 2026."

"Fed Chair Jerome Powell is orchestrating policy against challenging circumstances as the Fed preserves its mission of taking inflation down to target while arriving at a soft-landing, and I expect future 'dot plots' to take account of evolving economic conditions," said The Bond Buyer Market Intelligence Analyst Jeff Lipton. "Although further easing is anticipated in 2026, it appears that the bar has been raised for additional rate cuts post-December 2025 FOMC."

Data dependence will rule 2026, he said, "as lingering concerns over inflation ? would argue against frontloading too many rate cuts, particularly given tariff-related price increases for various goods as well as higher service sector costs."

Lipton expects the impact from tariffs "to be short-lived, and service sector pricing is on a disinflationary course."