Bond markets sell off as 2-year muni yield hovers around 3%

Bond markets tumbled Friday as the war in the Middle East, higher oil prices and rising inflation remained at the forefront of market concerns.

Muni yields were cut eight to 13 basis points, depending on the scale, while UST yields rose nine to 14 basis points.

Muni yields followed UST yields higher, as the latter sold off sharply Friday on the heels of Brent Crude oil rising above $110 per barrel, shocking the market and raising concerns about inflationary risks, said Chris Brigati, managing director and CIO at SWBC.

Ten-year Treasury rates moved higher "pretty aggressively" intraday, rising from 4.26% to 4.39%. This 13-basis-point rate move in Treasuries dragged munis with it, he said.

Some analysts speculate oil could rise to $180 per barrel if nothing changes in a month, with no resolution to the war in the Middle East in sight, said Matt Fabian, president of Municipal Market Analytics.

"The markets are still trying to parse for clues as to when the war in the Middle East may start to de-escalate ? but headlines that may have eased concerns a few days ago, are being replaced with fresh ones that may point to an extended conflict and that is the reaction we may be seeing [Friday]," said Mohammed Murad, head of municipal credit research at PTAM.

While it's unclear how long the war in the Middle East will drag on, once President Donald Trump announces an end to the war, things could change "on a dime," as happened with the tariff-induced volatility in April 2025, said Peter Block, managing director of credit strategy at Ramirez.

"As soon [as the war] is over and the Strait of Hormuz is open, you're just going to have a huge rally, and then things will be back to normal," he said, noting that for the time being, financial markets are weaker.

Not everyone attributed the market selloff Friday to the war in Iran.

The cheapness was due to munis being so overpriced that the asset class needed an adjustment, said Tim McGregor, managing partner at Riverbend Capital Advisors.

This is something that was "long overdue, not related to the war or anything, but some of the valuations had to get back more in line, which we've seen some of that as well, especially like the 10-year and in stuff," he said.

Front-end valuations were "bad" to start with, and there was a huge move on the two-year Treasury, so there was some catching up to do, McGregor said.

Furthermore, some of the market weakness this week is a reaction to what happened with the Federal Reserve, which held rates at its meeting, along with the possibility that the European Central Bank will hike, said a sellside source.

The Fed futures market is predicting a 50/50 chance of one rate cut from the Federal Reserve this year and the central bank may even have to raise rates later in the year if the oil crisis drags on, Block said.

Overall, this month's muni market weakness "has been mostly driven by the parts of the market that have done well to start the year," said Barclays (BCS) strategists.

"The belly did very well early on, while long-dated bonds lagged; now in a stark reversal, the 5-10y maturity bucket has come under pressure, and even a never-ending SMA bid was not able to protect it from weakening," they said. "As a result, the 10s30s and 10s20s parts of the curve have flattened back to their November levels or even lower, dropping below the four-year average for the 10s20s slope, while also recouping their losses to start the year and more."

However, the sellside source noted the market volatility may be overdone.

"It's just an example of where people just overreact in the moment. And we have access to too much information, and it causes ? kneejerk reactions," they said.

Moreover, the volatility in the muni market looks like "a lot when you're right in the middle of it, but when you look back over a two-year period, we've covered similar terrain multiple times before, so you just got to kind of hang in there," the sellside source said.

Barclays (BCS) strategists, though, disagreed: "We never thought the current municipal selloff would be as bad as last year's, but we still feel that the asset class is not yet out of the woods and remain cautious, looking for better opportunities, especially when the pipeline is expected to pick up starting next week, which should put additional pressure on munis."

Concessions to current market valuations may be needed to digest next week's robust new-issue calendar outside a "sizable rally in the broader rates market," said J.P. Morgan strategists led by Peter DeGroot.

This comes "as reinvestment capital is wearing thin entering the final full week of [the] month, dealer inventories have less capacity to absorb excess supply, and fund inflows have shown signs of deceleration," they said.

Muni mutual funds saw sizable inflows of $1.8 billion for the week ending Wednesday, more than double the previous week, according to LSEG Lipper.

However, J.P. Morgan strategists note muni funds saw aggregate outflows Thursday, the first daily outflow since mid-January.

"Even if rates were to stabilize around current levels, investors can expect to put capital to work at adjusted levels next week," J.P. Morgan strategists said.

Some may have started putting money to work earlier, as yields are starting to reflect good value, particularly in the 15- to 20-year range. "If you're talking 4.5% to 4.75% for good, high-quality munis, that's 7.5% to 8% taxable equivalent yields," McGregor said.

Additionally, ratios out long at least 90%, might attract some institutional buyers, who have been reducing their muni holdings for years, he said.

New-issue calendar
The new-issue calendar is an estimated $10.67 billion, with $8.608 billion of negotiated deals on tap and $2.063 billion of competitives.

Illinois leads the negotiated calendar with $1.4 billion of general obligation bonds, followed by the Pennsylvania Economic Development Financing Authority with $1.043 billion of UPMC revenue bonds.

The competitive calendar is led by the Long Beach Unified School District, California, with $604.57 million of GOs in three series.