Municipal Bond News 1/5/26

Investment Grade Muni Bonds Outperform…2025 Yield Path…Demand For Muni Bonds Accelerates…January Reinvestments…Fed Cautious on 2026 Rate Cuts…Atlantic City Earns Investment Grade Rating…Chicago Fiscal 2026 Budget Approved…Chicago Board of Education Hikes Taxes…

Investment Grade Muni Bonds Outperform…In 2025, high yield muni bonds returned 2.4%, trailing the 4.4% return logged by higher-rated tax- free bonds. Uncertainty around federal support as well as troubles at a large high yield issuer (Brightline Trains Florida) can be attributed for the underperformance of the high yield muni bond sector. While the yield gap between muni bonds rated ‘Baa3’ or higher and top-rated tax-free benchmarks is at a multiyear low, there are opportunities for yield pickup in the niche high yield muni bond sector. A GMS Municipal Bond Specialist can help investors assess risk-reward and select muni bonds from a wide spectrum of tax-free sectors and ratings.

2025 Yield Path…In 2025, muni bond benchmark yields ranged from 3.85% (Jan-2025) to 4.86% (April-2025). Yields increased in the first four months due to robust supply, and peaked in April amid tariff-related volatility in financial markets. In early May, a reprieve on China tariffs led to a bond market rally, and tax-free bond yields dropped back to 4.42%. In July, yields climbed once again to 4.8%. Although the July 4, 2025 passage of the One Big Beautiful Bill Act eased uncertainty, July brought record high volume of new muni bonds in the primary market. Since August, tax-free yields dropped 70 basis points to 4.1% in October, and increased 10 basis points in the last two months of 2025. Amid volatile market conditions, investors purchased muni bonds to take advantage of higher tax-free yields.

Demand For Muni Bonds Accelerates…A gauge of investor demand, inflows to muni bond funds were close to $50 billion in 2025, up from $46 billion in 2024 and reversing $21 billions of outflows in 2023. In 2026, investors are likely to transition out of record $8 trillion in money market holdings in preparation for lower policy rates. Muni bonds, particularly higher-yielding tax-free bonds, are likely to receive some of the rotation out of cash. Top earners currently earn significantly higher taxable equivalent yields from tax-free state and local government bonds compared to taxable bonds.

January Reinvestments…On January 1, 2026, Muni bondholders will receive more than $13 billion in principal redemptions and much more in interest payments. That’s significantly more than the volume of new muni bonds likely to be issued this month. Over the next 30 days, close to $9 billion in new muni bonds are on the calendar. Reinvestment demand is unlikely to keep up with new issuance.

Fed Cautious on 2026 Rate Cuts…Bond markets assign 90 percent odds that the Federal Reserve will hold rates steady at its January meeting. In mid-December, some Fed officials suggested that “it would likely be appropriate to keep the target range unchanged for some time.” Since then, economic data show that strong consumer spending has helped fuel robust economic growth, even as unemployment has inched higher. At 3.5% to 3.75%, the Fed’s targeted interest-rate range is now the lowest in three years. For most of 2025, the Fed held interest rates steady. Since September, there have been three quarter-point rate cuts prompted by a cooling labor market. However, each rate cut has faced successively growing internal resistance.

Atlantic City Earns Investment Grade Rating…Moody’s upgraded Atlantic City to ‘Baa3’ from ‘Ba1’ last week. A decade after its financial crisis, the city now has stable operations and has been deceasing debt rapidly. Much of this progress has been possible due to state legislation that enabled the city to receive certain payments from casinos in lieu of traditional property taxes through the end of 2026. Atlantic City has been under state oversight since 2016. It is unclear if state oversight will be extended beyond 2026.

Chicago Fiscal 2026 Budget Approved…Chicago’s 2026 budget took effect on January 1. Mayor Johnson neither signed nor vetoed the City Council-approved fiscal spending plan. The mayor warns that emergency spending cuts may be needed if planned revenue does not materialize. The $16.6 billion spending plan does not include a ‘head tax’ on large corporations and seeks to engage a private company to collect overdue utility bills and traffic violation dues; both of these measures were opposed by the mayor. As proposed by the mayor, the city will transfer $550 million to Chicago Public Schools, which is more than the school district anticipated.

Chicago Board of Education Hikes Taxes…At a special meeting last week, Chicago Public Schools’ board voted 15-5 to hike property taxes up to the maximum legal limit. Chicago Public Schools is funded by local property taxes. CPS is allowed to raise the rate, but it is capped at the lower of either 5%, or the rate of inflation. When the district closed a $729 million budget deficit in August, it raised the levy slightly below the legal limit. The tax hike will generate $25 million for the school district.

Compare 30-Year taxable U.S. Treasury yield 4.87% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.18%; “AA” 4.45%; “A” 4.76%. For investors in the 35% tax bracket, a 4.16% tax-exempt yield is equivalent to a 6.4% taxable yield. Top-rated long-term tax-free bonds yield 86% of comparable taxable U.S. Treasuries.