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As we settle into 2025, the municipal bond (muni) market continues to exhibit strong demand, setting the stage for a potentially exceptional year in issuance.

The Bloomberg US Municipal Bond Index has delivered positive returns year-to-date, 0.73%, reflecting solid demand for tax-free income and favorable valuations.1,2 The positive performance in munis comes despite a robust year in primary issuance, as supply is up 32% year over year.3 However, this supply has been absorbed relatively well, with approximately $40.5 billion of net inflows into the market.4

Post-election impact

The US presidential election has significant implications for the muni market. With the Republican party gaining control in Washington, there are concerns about potential tax policy changes that could affect munis’ tax-exempt status. Historically, tax policy changes have been a critical factor influencing the attractiveness of munis.

We believe several factors may influence the muni market from a legislative perspective ...

We believe several factors may influence the muni market from a legislative perspective, whether it be deregulation, tax policy changes or the repeal of the tax exemption itself. All of which may have varying impacts across sectors.

In regard to the repeal of the tax exemption itself, it is our view that this is of low probability, and any action to eliminate or cap the exemption could result in existing munis exemption to be grandfathered in. This would likely increase the demand for tax-exempt muni debt under this scenario, which could actually boost returns.

New year, new muni rally?

Looking ahead at 2025, we expect a relatively strong year in the muni market – particularly in Q1. We believe the technical factors will be positive in the first month of 2025. January often sees significant bond maturities and interest payments, which investors typically reinvest into the market. This influx of capital creates a high demand for new and existing bonds, driving up prices in the secondary and primary markets.

Issuance trends and forecasts

November's issuance was lower than the previous year's total for the same month. However, the market is still on pace to break 2020's records and will likely reach $500 billion in total issuance.5 While supply may have slowed in December and potentially into January 2025, we anticipate another heavy year for muni issuance. Most forecasts suggest an initial target of around $500 billion for 2025.5

Cruising altitude?

The question investors face now is whether the Fed will action any rate cuts in 2025. And if so, at what pace?

We believe that potential inflationary policies bandied about by the new administration ... should make 2025 a good year for coupon clipping or carry trade opportunities despite less potential action out of the Fed.

We believe that potential inflationary policies bandied about by the new administration – and the shape of the yield curve in the muni market – should make 2025 a good year for coupon clipping or carry trade opportunities despite less potential action out of the Fed. Those opportunities are often found on the short and long end of the duration spectrum and down the credit quality curve.

As the macro landscape's fundamentals remain solid, we look to add to opportunities in lower credit quality and a barbell approach to duration as yield opportunities become available.

Infrastructure needs …

One key factor driving the expected rise in infrastructure investment in the US is the vital role the muni market will play. With substantial infrastructure needs across the country, local governments increasingly rely on munis to fund these projects effectively.

This market is essential for addressing the unique challenges and demands of infrastructure development at the community level.

This market is essential for addressing the unique challenges and demands of infrastructure development at the community level. Demand for infrastructure projects ensures a steady stream of new bond issuances as municipalities seek to finance these initiatives.

… And high interest rates

Additionally, we believe the current high interest rate environment makes munis an attractive option for investors looking to deploy capital. Elevated tax-exempt yields provide a compelling opportunity for investors to earn higher returns while benefiting from the tax advantages that munis offer.

Sectors to watch

There are several sectors to keep as investors navigate the opportunities and risks associated with a new federal administration, the prospect of elevated issuance patterns, and higher interest rates. We note a few to keep an eye on below.

Charter schools

In our view, this sector has demonstrated its value through operational flexibility and academic outcomes. In addition, there has been legislative momentum in this area as more local authorities look to these issuers as part of the solution to the educational needs of their local communities.

Healthcare

This sector has rebounded from the operational pressures that plagued it in prior years. In 2024, these issuers saw staffing pressures subside, and inpatient revenues normalize back to pre-pandemic levels. The result was one of the best-performing sectors in the municipal market in 2024. We would note that operational results within the sector varied, as smaller rural operators did benefit from some of the economies of scale efficiencies seen by some of their multi-site counterparts.

In 2025, we believe the prospect of increased M&A activity may strengthen some single site or smaller participants in the market.

Final thoughts

We believe the US muni market is poised for improvement as we head into 2025. The combination of a technically positive environment in December and an anticipated strong technical environment in January, with substantial infrastructure needs, are all contributing factors. The overall outlook remains favorable, with strong demand and significant issuance expected in the coming year. Further, we believe active management is prudent during this period since the combination of tax policy changes, duration risks, and credit considerations will likely lead to a year of uneven and turbulent performance. For investors, munis continue to offer a reliable and tax-efficient investment option, particularly in a high interest rate environment.

1 The Bloomberg US Municipal Index is a flagship measure of the US municipal tax-exempt investment grade bond market.
2 Bloomberg US Municipal Bond Index, December 2024.
3 Bank of America Global Research, December 2024.
4 LSEG Lipper Global Fund Flows, December 2024.
5 "Munis improve ahead of rebound in issuance." The Bond Buyer, November 2024. https://www.bondbuyer.com/news/munis-improve-ahead-of-rebound-in-issuance.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Indexes are unmanaged and have been provided for illustrative purposes only. No fees or expenses are reflected. You cannot invest directly in an index.

High yield securities may face additional risks, including economic growth; inflation; liquidity; supply; and externally generated shocks.

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

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