Municipal Market Outlook: High After-Tax Yields in an Uncertain World

Despite volatility, muni markets finished strong in 2025, and we are optimistic for a repeat in 2026. We expect steady investor demand and rate cuts to continue to fuel market momentum. In our view, investors who stay flexible will be best positioned to navigate volatility and seize new opportunities. And given munis’ high after-tax yields, investors could be well compensated along the way.

Rate Cuts, Supply and Demand to Set the Tone

As in 2025, the path to higher returns in 2026 won’t be a straight line. We expect several factors to shape municipal market performance, starting with interest rates. A divided Federal Reserve resumed easing in December, although long-delayed jobs and inflation data led them to hint at a pause in January. Barring a major upside surprise, however, we think policymakers will eventually continue to cut—and have the room to do it.

Inflation remains high in some areas of the economy but well below 2022 peaks. Unemployment levels appear stable yet weaker, with hiring clearly slowing in some sectors. And we anticipate cooling economic growth. As a result, we expect the Fed to cut the benchmark rate to 3%, and possibly lower, over the coming year.

One potential headwind in 2026 is an increase in new issuance. Muni market new issuance hit a record $565 billion ($517 billion tax-exempt and $48 billion taxable) in 2025. According to J.P. Morgan, with municipalities facing rising capital improvement costs, issuance is likely to reach $600 billion ($545 billion tax-exempt and $55 billion taxable) in 2026.

Heavy issuance typically raises concerns about whether investor demand will keep pace. In early 2025, demand slackened as investors worried about trade-war fallout and munis’ tax-exempt status under the One Big Beautiful Bill Act. But today those anxieties appear to be in the rearview mirror. Demand for municipals has surged, with inflows into muni funds reaching $50 billion in 2025.

A potentially significant tailwind: nearly $8 trillion sidelined in money market funds, waiting for re-entry. We expect a portion of that to return to bond markets over the coming two to three years as the Fed eases and cash rates fall.

When investors look for the most attractive risk-adjusted opportunities to deploy that cash, municipals are likely to top the list. The tax-equivalent yields for investment-grade and high-yield municipals are roughly 6% and 9%, respectively. For investors who pay taxes on capital gains, these yields compare favorably to returns in most other asset classes. The hunt for higher yields may push municipal bond prices higher.

Work the Curve, Target Credit

Compelling yields, a steep yield curve, strong credit fundamentals and an easing Fed continue to offer attractive entry points for muni investors. Against this backdrop, consider the following strategies:

1. Lengthen duration. Investors should consider lengthening their portfolio duration, or sensitivity to interest-rate changes, relative to the benchmark. We expect yields to fall as the economy continues to slow and the Fed revisits its rate-cutting cycle. Falling yields benefit bond prices, especially at longer durations.

2. Lift a barbell. We think it’s also a good idea to pair longer maturities with short-term bonds in a “barbell” maturity structure. In our analysis, both the short and long ends of today’s municipal yield curve are attractively valued when comparing current spreads to their five-year averages (Display).

We think investors should focus on maturities outside of 15 years, where the yield curve is especially steep (Display).

These bonds don’t only offer comparatively high yields—they also benefit from roll. When a curve is upward sloping, the yield on a bond declines as it approaches maturity. Because yield and price move in opposite directions, its price rises. The steeper the curve, the bigger the price effect from roll. Plus, if the curve flattens, which we expect, yields on those longer bonds would fall, lifting their prices.

That said, a barbell structure isn’t the right choice for every yield-curve shape, so it’s important to stay flexible.

3. Give yourself some credit. Credit—namely A-rated, BBB-rated and high-yield muni bonds—continues to offer compelling incremental income and attractive spreads, in our view.

Fundamentals remain strong; most municipalities are in good financial health, with near record-high reserves and layers of budget flexibility at their discretion.

Even so, investors should remain selective. We currently see compelling opportunities among pre-pay energy bonds, which are a type of muni revenue bond used by public utilities to lock in long-term rates with an energy provider at a discounted price. Pre-pay structures carry spreads that are meaningfully wider than comparable generic high-grade municipals—a built-in yield pickup today and the potential for future spread compression.

For similar reasons, we think Low-Income Housing Tax Credit (LIHTC) bonds also offer compelling opportunities. LIHTC is a federal program created in 1986 to incentivize the development and rehabilitation of affordable rental housing. LIHTC deals typically come with yields equivalent to 200–250 basis points of additional spread relative to high-grade municipals. Yet historical default rates align with investment-grade munis at around 0.5%.

We think the municipal bond market is poised for solid performance in 2026, thanks to favorable economic conditions, robust demand and anticipated rate cuts. To best take advantage of opportunities, however, investors should remain active and flexible, focusing for now on longer durations, barbell strategies and high-quality credits, and preparing for new opportunities to emerge. In today’s dynamic market, flexibility isn’t just an advantage—it’s essential.