Perspectives

Municipal bonds posted significant losses in the fourth quarter, dragged down by a broader Treasury market selloff. Interest rates surged across the curve as solid economic data challenged expectations for an aggressive Fed easing cycle. Strong consumer spending, resilient labor markets, and robust GDP growth all painted a picture of continued economic momentum. Meanwhile, inflation remained above target with progress seemingly stalled. Core inflation showed signs of leveling off, with some components, like housing services, declining more slowly than expected. The Republican sweep in November only added to the volatility as it raised questions about the impact of fiscal policy, including the extension of tax cuts and potential tariff and immigration measures that could stoke longer-term price pressures. The Fed responded by taking a more cautious policy approach, signaling fewer rate cuts in 2025 than markets had anticipated. The 10-year Treasury yield, which hit a low of 3.61% in September, jumped nearly 100 basis points to end the year over 4.50%.

Municipal bonds mirrored the broader market’s selloff, but managed to slightly outperform Treasuries. October’s record surge in issuance — almost 70% from the prior year — initially strained the market, but a sharp slowdown in November and December provided some relief. Despite the rising-rate environment, investor appetite for municipal bonds remained strong throughout much of the quarter, bolstered by mutual fund inflows and seasonally high reinvestment demand. Municipal/Treasury ratios, already historically rich, tightened further as solid technicals mitigated the move higher in yields. After steepening through the middle of the year, the municipal bond yield curve flattened in the fourth quarter, reflecting the now less aggressive, more data-dependent Fed. The market limped into year-end as a surge of eleventh-hour tax-loss selling was met by an indifferent buyer base with no primary issuance to provide price discovery. The predictable spike in yields, however, felt more like a technical correction than a fundamental shift in sentiment.

Our trading activity in the fourth quarter capitalized on many of the same factors that defined the year: record issuance and thin secondary activity. In 2024, over $500 billion came to market, including a wave of “mega deals” exceeding $1 billion. Significant dealer concessions were necessary to clear the surge, creating abundant opportunities for those able to identify and participate in the action. Over two-thirds of our purchases for the year came from the primary market, where we selectively targeted deals offering the most value and potential upside. Most of the deals we bought saw spreads tighten back to norms once the temporary issuer saturation dissipated and scarcity value returned, delivering immediate benefits for our clients. We funded these purchases through sales across the curve, though primarily at the shorter end, focusing on bonds with the tightest spreads. Given the rich ratio environment and relatively flat curve, we maintained a cautious stance on extending duration further.

The municipal bond market enters 2025 with solid fundamentals and a promising technical backdrop. State and local governments remain in strong financial shape, bolstered by healthy reserves and stable revenues. Meanwhile, historically attractive yields and favorable supply and demand dynamics should provide added support into the new year. Persistent inflation risks and fiscal policy developments could introduce headwinds, possibilities that have led the Fed to adopt a more cautious stance only a few months into the current easing cycle. Even so, we see opportunities to lock in elevated tax-equivalent yields, particularly in segments of the curve where roll and spread potential are most attractive. For long-term investors, any near-term turbulence could be a chance to build positions at improved valuations.

With contributions from members of our Municipal Bond Team