Weekly Municipal Monitor—Midyear Update

Blog

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

Macros, Markets and Munis

Municipals posted positive returns last week and outperformed taxable fixed-income as markets focused on labor data that showed JOLTS job openings were unchanged but came in above expectations. On Thursday, July 2, the June employment report indicated that nonfarm payrolls increased by a below-expected 57,000, with downward revisions to April and May data. The unemployment rate edged down to 4.2% from 4.3% amid a decline in labor force participation. Meanwhile, new Federal Reserve Chair Kevin Warsh noted that inflation risks have eased. Treasury yields rose 4 to 12 basis points across the curve; municipals outperformed, moving modestly lower in most maturities amid heavy demand and light supply. This week we provide a midyear muni market update.

Technicals Improved on Stronger Demand and Lighter Supply

Fund Flows ($1.7 billion of net inflows): During the week ending July 1, weekly reporting municipal mutual funds recorded $1.7 billion of net inflows, marking an 11th consecutive week of inflows, according to Lipper. The long-term category led demand with $1.1 billion of inflows, the short-term category recorded $219 million of inflows and the intermediate category reported $292 million of inflows. Inflows last week bring year-to-date (YTD) inflows to $53 billion.

Supply (YTD supply of $304 billion; up 10% YoY): The muni market recorded $5 billion of new-issue supply last week, down 65% from the prior week’s level due to the July 4 holiday. YTD new-issue supply of $304 billion is 10% higher than the prior record-issuance year, with tax-exempt issuance up 10% year-over-year (YoY) and taxable issuance up 7%, respectively. This week’s calendar is expected to rebound to $16 billion. Largest deals include $2.4 billion Aquarion CT Water Authority and $1.8 billion California State University transactions.

This Week in Munis: Midyear Update

Performance

The municipal market posted strong returns during the first half of the year despite geopolitical tensions and ongoing inflation uncertainty. Rate expectations shifted meaningfully over the period, moving from anticipated 2026 rate cuts at the start of the year toward renewed concerns about higher-for-longer policy and potential rate hikes by midyear. Treasury yields rose across the curve, while the municipal yield curve generally flattened, with intermediate municipal yields increasing and longer maturities declining. Against this backdrop, the Bloomberg Municipal Bond Index returned 2.32%, outperforming both the Bloomberg Treasury Index, which returned 0.28%, and the Bloomberg Corporate Index, which returned 0.86%. Strong demand, particularly from longer-duration vehicles, helped absorb elevated new issuance and supported municipal outperformance during the period.

Supply/Demand

Supply: New issuance reached $295 billion in the first half of 2026, according to Bloomberg, up 7% from 1H25 and maintaining a record pace. Tax-exempt municipal issuance totaled $274 billion, up 6% YoY, while taxable supply of $21 billion was 20% below prior-year levels. A key driver of higher issuance was continued growth in prepaid gas issuance, which totaled $24 billion, more than double the prior-year level. The sector has continued to diversify the broader municipal market, expanding issuance beyond traditional governmental borrowers into corporate-backed issuance, with Google-parent Alphabet participating in its first-of-kind $1.2 billion tax-exempt structure this year.

Demand: Municipal mutual funds recorded approximately $58 billion of net inflows in the first half of the year, according to ICI, well above the $19 billion recorded through the first half of 2025. Municipal mutual funds have now attracted $161 billion of cumulative net inflows since January 2023, complementing persistent SMA demand in the marketplace. YTD flows have been concentrated largely in longer-duration strategies, according to Lipper, supporting the outperformance of longer-maturity municipals.

Fundamentals

The municipal market navigated a budget season marked by reduced federal support and ongoing cost pressures. However, resilient economic growth and a healthy labor market continued to support record tax collections and broadly stable municipal credit fundamentals. The US Census Bureau’s 1Q26 state and local tax collection estimates showed total collections rising 5.5% YoY on a trailing 12-month basis to a record $2.22 trillion. Individual income taxes were the primary growth driver, increasing 10.0% YoY. Sales tax collections rose 3.8%, property tax collections increased 2.1% and corporate income tax collections grew more modestly, rising 0.8%.

While credit fundamentals remain strong across most of the municipal market, rating actions have begun to reflect moderate growth expectations and persistent cost pressures. As a result, the pace of rating improvement slowed in 1H26. According to Bloomberg data through June 18, upgrades from the three major rating agencies (Moody’s, S&P and Fitch) continued to outnumber downgrades by issuer count, with 540 upgrades versus 509 downgrades. However, downgrades exceeded upgrades by par value, with $101 billion downgraded versus $88 billion upgraded. Meanwhile, first-time payment defaults totaled $692 million, below the $1 billion recorded during the prior-year period.

Valuations

Despite strong nominal and relative returns so far this year, Western Asset believes value persists in the municipal market. The average yield-to-worst of the Bloomberg Municipal Bond Index ended June at 3.6%, roughly in line with the start of the year and equivalent to a tax-equivalent yield of approximately 6.0%, assuming a top marginal tax rate of 40.8%. Relative after-tax income opportunities remain favorable out the yield curve and across lower investment-grade to high-yield credit. We believe these opportunities remain compelling in an environment where equity valuations appear elevated and corporate credit spreads remain tight. However, recent outperformance has narrowed broad relative value, underscoring the importance of security selection within the market.

Muni After-Tax Yield Pickup by Quality Cohort

Municipal Credit Curves and Relative Value

Western Asset Key Themes for Muni Investors

Theme 1: Municipal taxable-equivalent yields remain elevated relative to historical averages.

Muni and Taxable-Equivalent Muni Yield-to-Worst

Theme 2: Munis offer attractive after-tax yield pickup vs. longer-duration or lower-quality taxable alternatives.

Theme 3: The muni curve remains steep and offers relative value in longer maturities.

Municipal vs. Taxable Fixed-Income Yields by Quality

© Western Asset Management Company, LLC 2026. 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.

For the Franklin Templeton global-non product disclosures, please click here.

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.