Weekly Municipal Monitor—Yield Curve Disinversion

Blog

Stay up to date on timely topics and market events. Subscribe to our Blog now.

Investment-Grade Munis Posted Positive Performance Last Week

Investment-grade munis posted positive returns during the week as high-grade muni yields moved lower across the yield curve. Municipal yields underperformed Treasuries (which moved lower on dovish rhetoric) as earnings reports highlighted signs of slower consumer spending and inflation trends moving lower. Meanwhile, muni supply and demand remained elevated. The Bloomberg Municipal Index returned 0.09% during the week, the High Yield Muni Index returned 0.07% and the Taxable Muni Index returned 0.37%. This week we highlight recent yield curve reversion and the potential implications for muni investors.

Muni Supply and Demand Both Trended Higher Last Week

Fund Flows (up $866 million): During the week ending July 24, weekly reporting municipal mutual funds recorded $866 million of net inflows, according to Lipper. Long-term funds recorded $745 million of inflows, high-yield funds recorded $252 million of inflows and intermediate funds recorded $130 million of inflows. This week’s inflows led estimated year-to-date (YTD) net inflows higher to $14 billion.

Supply (YTD supply of $273 billion, up 41% YoY): The muni market recorded $11 billion of new-issue volume last week, down 8% from the prior week. YTD issuance of $273 billion is 41% higher than last year’s level, with tax-exempt issuance 45% higher and taxable issuance 3% higher year-over-year (YoY). This week’s calendar is expected to remain elevated at $9 billion. The largest deals include $1.1 billion New York City General Obligation and $920 million Port of Seattle transactions.

This Week in Munis: Yield Curve Disinversion

Throughout the majority of 2023 into 2024, the muni yield curve has remained stubbornly inverted. Shortest-term yields have been buoyed higher by the Federal Reserve (Fed) hiking cycle, coupled with short-term muni demand as many investors shifted shorter allocations to money market funds and other cash equivalents yielding greater than 5%. Meanwhile, intermediate maturities, particularly securities within five to 10 years, were anchored lower by expectations that the Fed would eventually cut interest rates but exacerbated by strong separately managed account (SMA) investment.

The front end of the municipal yield curve has materially disinverted since the beginning of the second quarter. AAA muni yields, which were as low as 2.48% from five to nine years, moved 27 basis points (bps) higher on average. Meanwhile, as inflation data moved lower and market expectations coalesced around a Fed cut later this year, maturities of one year and less moved over 30 bps lower.

The municipal bond yield curve inversion had challenged certain muni strategies, including SMAs which predominantly invest within 10 years, with relatively lower yield opportunities and rolldown benefits for bearing additional duration risk. As the yield curve reverts to more historical norms, Western Asset anticipates both income opportunities and rolldown benefits should improve. We also believe that curve normalization will contribute to a stronger technical environment, as we expect investors will continue to look to longer-duration income alternatives as short yields move lower. The heightened municipal mutual fund flows observed in recent weeks as the front end of the curve rallied could be an early indication of the increased demand that we could see if the curve continues to normalize.

One-Year Municipal Bond Index YTW vs. Weekly Muni Fund Flows

Municipal Credit Curves and Relative Value

Western Asset Key Themes for Muni Investors

Theme #1: Municipal taxable-equivalent yields and income opportunities are above decade averages.

Muni and Taxable-Equivalent Muni Yield-to-Worst

Theme #2: The muni yield curve has disinverted, offering greater value in extending maturities.

Theme #3: Munis offer attractive after-tax yield pickup versus longer-dated Treasuries and investment-grade corporate credit.

Municipal vs. Taxable Fixed-Income Yields by Quality

© Western Asset Management Company, LLC 2025. The information contained in these materials ("the materials") is intended for the exclusive use of the designated recipient ("the recipient"). This information is proprietary and confidential and may contain commercially sensitive information, and may not be copied, reproduced or republished, in whole or in part, without the prior written consent of Western Asset Management Company ("Western Asset").

Past performance does not predict future returns. These materials should not be deemed to be a prediction or projection of future performance. These materials are intended for investment professionals including professional clients, eligible counterparties, and qualified investors only.

These materials have been produced for illustrative and informational purposes only. These materials contain Western Asset's opinions and beliefs as of the date designated on the materials; these views are subject to change and may not reflect real-time market developments and investment views.

Third party data may be used throughout the materials, and this data is believed to be accurate to the best of Western Asset's knowledge at the time of publication, but cannot be guaranteed. These materials may also contain strategy or product awards or rankings from independent third parties or industry publications which are based on unbiased quantitative and/or qualitative information determined independently by each third party or publication. In some cases, Western Asset may subscribe to these third party's standard industry services or publications. These standard subscriptions and services are available to all asset managers and do not influence rankings or awards in any way.

Investment strategies or products discussed herein may involve a high degree of risk, including the loss of some or all capital. Investments in any products or strategies described in these materials may be volatile, and investors should have the financial ability and willingness to accept such risks.

Unless otherwise noted, investment performance contained in these materials is reflective of a strategy composite. All other strategy data and information included in these materials reflects a representative portfolio which is an account in the composite that Western Asset believes most closely reflects the current portfolio management style of the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from other accounts in the composite. Information regarding the representative portfolio and the other accounts in the composite are available upon request. Statements in these materials should not be considered investment advice. References, either general or specific, to securities and/or issuers in the materials are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendation to purchase or sell such securities. Employees and/or clients of Western Asset may have a position in the securities or issuers mentioned.

These materials are not intended to provide, and should not be relied on for, accounting, legal, tax, investment or other advice. The recipient should consult its own counsel, accountant, investment, tax, and any other advisers for this advice, including economic risks and merits, related to making an investment with Western Asset. The recipient is responsible for observing the applicable laws and regulations of their country of residence.

Founded in 1971, Western Asset Management Company is a global fixed-income investment manager with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Zürich. Western Asset is a wholly owned subsidiary of Franklin Resources, Inc. but operates autonomously. Western Asset is comprised of six legal entities across the globe, each with distinct regional registrations: Western Asset Management Company, LLC, a registered Investment Adviser with the Securities and Exchange Commission; Western Asset Management Company Ltda. is regulated by Comissão de Valores Mobiliários; Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services License 303160; Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services License for fund management and regulated by the Monetary Authority of Singapore; Western Asset Management Company Ltd, a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan; and Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority ("FCA") (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.