How the Muni Curve Turned

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<h3>James A. Klotz</h3>

James A. Klotz

Remember the inverted yield curve?

It’s history. After 18 months of unusual contortions, the market has righted itself. In fact, the curve has recently steepened to levels we haven’t seen in a decade, once again presenting opportunities for long-term investors.

The yield curve reflects the relationship between short- and long-term yields. Normally, the further out you go, the higher the yield. Its shape signals whether investors are being rewarded for extending to longer maturities.

Today’s curve reflects a sharp contrast between the short and long ends of the market. Two-year AAA muni yields have eased by approximately half a percentage point this year, while 30-year AAA yields have climbed more than 70 basis points, according to Goldman Sachs.

That divergence has created one of the steepest slopes between short and long maturities in recent history.

How the muni curve turned

Inverted yield curve

For much of 2023 and into last year, the municipal yield curve was inverted, an uncommon occurrence where shorter maturities yielded more than longer ones.

A variety of factors contributed to the inversion. The Fed went through a cycle of tightening short-term interest rates and there was a surge of new issuance on the long end.

That imbalance has changed.

With short-term yields noticeably lower than 30-year bonds, the more traditional pattern has returned, where investors earn more by committing money for longer periods.

Recently, for example, 30-year, A-rated bonds have a taxable equivalent yield of a whopping 8.65% for those paying the 40.8% tax rate.

The last time the muni curve was this steep was a decade ago, while yields at today’s levels have been rare.

Meantime, about $7 trillion remains parked in money-market funds. As yields in these funds drift lower, tax-exempt bonds offer a rewarding way to put that sidelined cash to work.

Solid fundamentals

Municipal credit remains solid. States and localities recently reported reserves near historic highs backed by conservative budgeting and healthy tax collections, which underpin the market’s strength, according to Western Asset. In fact, many states have historically high rainy-day funds.

The supply of long-term bonds is up about 22% this year compared to last year, Goldman Sachs said. This heavy issuance has pushed yields higher, and with more bonds available across states, sectors and maturities, investors now have more flexibility in building their portfolios to fit their income goals (“Dynamic Muni Market Prizes Informed Investors”).

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    This appeal also extends beyond traditional high-net-worth investors. Retirees looking for steady, predictable income can lock in attractive yields. Younger investors can take advantage of the curve to build long-term income streams. Others in higher brackets will find tax-equivalent yields competitive with much riskier asset classes.

    As Kiplinger’s recently noted, today’s market opens the door for a wide range of investors. With abundant supply across states and maturities, they also have plenty of municipal bond choices to fit their needs.

    Of course, issuance might slow and falling money-market yields will continue to draw more investors toward long-term municipal bonds, with the potential of causing those attractive rates to decline.

    For investors, it all adds up to a market that currently presents unusually favorable opportunities.

    James A. Klotz

    President

    James A. Klotz is the President of FMSbonds, Inc.
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    Sep 4, 2025