Municipal bonds have experienced notable underperformance relative to U.S. Treasuries this year, especially long-dated muni bonds. While rate moves can explain a portion of this underperformance, supply and demand dynamics within the muni market have also played a significant role. Not only is muni market supply running well ahead of last year’s pace but the type of issuers and investors participating in the market has skewed the technical picture in favor of short-dated munis. The result is a far steeper muni yield curve and relative values that far exceed long-term averages.
Municipal bonds are generally thought of as a rates product and highly correlated with the broader Treasury market. However, municipal bonds—especially long-dated ones—have underperformed Treasuries since the beginning of 2025. For context, long-dated municipal bonds have sold off 77 bps while short-dated muni bonds have rallied 43 bps. Over the same period, 30-year Treasuries have risen 12 bps and two-year Treasuries fell 28 bps. Put more simply, the municipal curve steepened by 120 bps and the Treasury curve steepened by 40 bps. (Fig 1). This raises questions about why munis have underperformed by so much.
Figure 1
The muni curve has steepened sharply in 2025
Source: Bloomber as of August 2025.
Part of this underperformance can be tied to the supply picture. Issuance is running 15-20% ahead of last year’s record level and is largely a function of elevated supply from issuers in the healthcare, university, and transportation sectors (Fig 2).
Figure 2
Hospitals, airports, universitities lead elevated supply
Source: Bloomberg as of July 2025.
While healthcare and universities have been issuing bonds to build balance sheets in preparation for Washington-induced financial strains, airports have returned to the market to increase capacity for a post-COVID resurgence in travel. This elevated supply, which has disproportionately increased the amount of long municipal bonds, has pushed long rates higher (Fig 3). Meanwhile, Treasury issuance has been concentrated at the front end with recent long-bond supply running at less than half of front-end issuance. The Treasury is also increasing the frequency of its buybacks of nominal long-end bonds.
Figure 3
Supply has disproportionately been focused on the long end
Source: Bloomberg, JP Morgan as of August 2025.
Short-term funds see inflows
Municipal bond supply is not the sole reason for underperformance: municipal demand has also played a role. Municipal holders are predominantly retail buyers that benefit from the federally tax-exempt interest and overwhelmingly favor 15-year maturities and in. Retail buyers include Separately Managed Accounts and intermediate/short funds, which make up ~77% of the market and their preference has led to a sharp divergence in fund flows. While shorter-dated open end funds have seen $5.5 billion in inflows so far this year, longer-dated ones have experienced $2.5 billion in outflows.
This leaves a small number of institutional buyers to support longer maturities. However, banks (the largest institutional buyers of municipal bonds) have been reducing their muni bond holdings since the 2017 Tax Cuts and Jobs Act reduced the benefit of the tax exemption by lowering their tax rate from 35% to 21%.
Rolling down the curve
The supply and demand dynamics described above have left long municipal rates and relative values at levels well above their long-term averages. Thirty-year AAA muni yields as a percentage of U.S. 30-year Treasury rates is now 95%, or well above the five-year average of 88% (Fig 4). The absolute level of rates of 30-year muni bonds have not been this high since 2011 and appear increasingly rich compared to corporate bonds as credit spreads there have compressed.
Figure 4
AAA Muni/Treasury Ratio
Source: Barclays as of July 2025.
This value proposition, extends beyond just the realm of “carry,” or the amount earning from interest alone. As total return buyers, we look for additional sources of return from spread tightening and “rolling down” the yield curve. In an upward sloping yield curve environment, investors can benefit from the price appreciation that occurs as time elapses and the bond “rolls down” to an earlier, lower portion of the yield curve. Price appreciation from rolling down the yield curve is more pronounced when the yield curve steepens—as has been the case this year.
While the broader rate market appears poised to move steeper (with a dovish Fed and potentially higher inflation from tariffs), the relative attractiveness of the long rates and yield curve slopes observed in the municipal market appear attractive. Despite the challenges posed by elevated supply and investor preferences, current market conditions present an attractive opportunity for total return buyers. The steep yield curve and the potential for price appreciation from rolling down the curve make long-dated municipal bonds a compelling investment option.
We’ve already observed some cross-over buyers (who weigh the economics of investing in the municipal market against other markets) come to the market to buy longer bonds. While this has provided some nascent support to the long end and exerted some downward pressure on the yield curve, long-dated muni bonds remain quite cheap versus their long-term average.
1 H.Con.Res.14, a resolution to establish the congressional budget for the United States Government for fiscal year 2025 and setting forth the appropriate budgetary levels for fiscal years 2026 through 2034.
2 Medicaid eligibility is based on a percentage of the federal poverty level (FPL). The exact percentage varies by state and household size. In 2024, the FPL was $15,060 for a single person in the continental United States. For each additional person in the household, the FPL increases by $5,380.
3 Source: 2024 State Expenditure Report (NASBO).
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Source(s) of data (unless otherwise noted): PGIM Fixed Income, as of August 2025.
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