Munis close 2024 with higher yields, record issuance and vast uncertainty ahead

Municipals had a stronger tone Tuesday as investors closed their books ahead of the New Year holiday while U.S. Treasuries were mixed and equities saw losses for the final session of 2024.

While municipals have outperformed USTs on the whole in 2024, they will close December with losses. How taxables perform in early 2025 coupled with macroeconomic and policy uncertainty have municipal market participants on edge for what lies ahead.

Triple-A muni yields were little changed to stronger by one to four basis points in spots Tuesday, depending on the curve, while USTs saw small improvements on the front end and small losses 10-years and out. The 10-year UST closed at 4.571% while the 10-year muni sat at a range of 3.05%-3.11% per triple-A scales.

“The ongoing concern that inflation has not been relegated to the rear-view mirror remains an underlying theme for the market,” said Chris Brigati, chief investment officer at SWBC.

The sharp upward move in 10-year UST yields since the Federal Reserve announced its initial rate cut in September indicates “the bond market has clearly had a different take on the inflation picture, and participants are voting with their portfolios,” he said.

While the market did not “reclaim the April high of 4.73%,” Brigati said “technical and fundamental factors suggest that not only will rates eventually test this support, but my expectation is that we will see a 5% yield handle sometime in the first quarter of 2025.”

Municipals have outperformed USTs in December and on the whole of 2024, but still will close out 2024 with municipal prices and yields “at roughly their worst of the year, leaving capital gain-only measures and many mutual fund/exchange-traded fund NAVs showing negative year-to-date returns,” noted Matt Fabian, partner at Municipal Market Analytics, Inc. ”Most AAA muni yields are ending 2024 about 50-75 basis points higher and fund NAVs are negative; losses will hurt some asset raising efforts but higher yields will help separately managed account-style income strategies in 2025.”

The losses won’t help gather assets “for total return managers next year, but it’s a good thing for income sellers ahead of 2025’s risks,” he said.

The investment-grade Bloomberg Municipal Index was in the red at -1.59% in December as of Tuesday, posting returns of 0.91% for 2024. Bloomberg’s high-yield index was faring worse at -1.77% for the month but seeing 6.21% of returns for 2024. Taxable munis were -2.29% in December and +1.74% in 2024 while short index munis were in the black at 0.18% this month and seeing returns of 3.09% in 2024.

Corporates were seeing losses of 1.74% in December with positive returns of 2.32% in 2024 while USTs were seeing losses of 1.46% in December with just +0.66% returns this year.

Ratios close the year at still-rich levels compared to historicals, but slightly higher on the short end compared to where they began it. The two-year municipal to UST ratio Tuesday was at 66%, the five-year at 65%, the 10-year at 67% and the 30-year at 81%, according to Municipal Market Data’s 1 p.m. EST read. ICE Data Services had the two-year at 66%, the five-year at 65%, the 10-year at 67% and the 30-year at 80% at 4 p.m.

They opened this year with the two-year at 56%, the three-year at 57%, the five-year at 57%, the 10-year at 58% and the 30-year at 84%, according to MMD.

“Municipal ratios as a percentage of Treasuries remain more expensive from a historical perspective, but absolute yields continue to entice investors with attractive levels,” Brigati said.

Fabian said expectations of a strong new-issue borrowing year, led off by a very strong first quarter, “mean underwriters will need every basis point of yield and spread they can get.”

“Note that, despite only an average December issuance total of ~$35B, which is the smallest total since the summer, the month already has 1.34M trades in the books: highest number of the year and highlighting the durability and strength of SMA demand for product, especially with more income now available,” Fabian said.

“So where normally a reliance on one investor type is a weakness — especially seeing the recent reversal of fund inflows and the accelerating runoff from banks — the bid from SMAs has been strong enough (so long as yields are high enough),” he said.

Fabian noted there has been a “seemingly accelerating bank exit from municipals” since the election, which “suggests wider spreads for smaller safe-sector borrowers (and a related opportunity for retail buyers) in 2025.” 

Indeed, Bank ownership of munis fell to $497.2 billion, down 0.3% from the second quarter of this year and a decrease of 4.3% from third quarter 2023 while brokers and dealer muni holdings fell the most quarter-over-quarter, declining by 10.5% to $16.2 billion, according to the latest Federal Reserve data from early December.

“The growing catalog of state borrowers forecasting budget issues (CO, IL, MD, ME, NJ, NY, RI, WA and the rest), not to mention cities doing the same, imply softer/worse rating trajectories and thus a standing need for institutional investing as well,” Fabian said.

The muni market saw a record $507.585 billion of debt issued in 2024, up 31.8% from $385.061 billion in 2023, according to LSEG data. Fabian said the potential for another year of record issuance “is realistic, especially if Build America Bond issuers, concerned about the fate of 2026 subsidies and rising tax-exempt yields, accelerate tender activity.”

Climate and severe-weather-related concerns may also drive more issuance as state and local governments need to address rebuilding older infrastructure on top of the deficits that already exist.

“And then there’s Washington, D.C.,” Fabian said, noting the “rapidly worsening federal budget challenges imply both excess UST issuance and threats to U.S. credit ratings.”

The U.S. borrowing cap resumes on midnight Wednesday, bringing with it the risk of a prolonged political impasse that invites market dislocation, downgrades and other headwinds for municipal bond issuers and investors.

The knock-on effects to municipal credits may be smaller but the implications of higher UST yields most certainly will drag munis along for the ride.

“The trajectory of UST yields is assumed to be higher, especially if trade wars or other factors restart inflation fears,” he said.

This is not to mention the potential for threats to the tax exemption that many in the industry expect to be on the negotiating table.

Republicans take full control of the Congress on Friday. They will need to either pass the debt ceiling provision as part of a budget reconciliation bill or secure Democrats’ support for passage of a separate bill.

AAA scales
MMD’s scale was unchanged: The one-year was at 2.86% and 2.82% in two years. The five-year was at 2.87%, the 10-year at 3.06% and the 30-year at 3.90% at 1 p.m.

The ICE AAA yield curve was bumped up to one basis point: 2.90% (-1) in 2025 and 2.83% (-1) in 2026. The five-year was at 2.84% (-1), the 10-year was at 3.05% (-1) and the 30-year was at 3.83% (-1) at 2 p.m.

The S&P Global Market Intelligence municipal curve was bumped one to two basis points: The one-year was at 2.87% in 2025 and 2.80% in 2026. The five-year was at 2.86%, the 10-year was at 3.06% and the 30-year yield was at 3.85% at 2 p.m.

Bloomberg BVAL was bumped one to four basis points: 2.95% (-1) in 2025 and 2.80% (-2) in 2026. The five-year at 2.85% (-4), the 10-year at 3.11% (-2) and the 30-year at 3.82% (-2) at 2 p.m.

Treasuries were mixed.

The two-year UST was yielding 4.24% (-1), the three-year was at 4.271% (-1), the five-year at 4.382% (+1), the 10-year at 4.571% (+3), the 20-year at 4.862% (+2) and the 30-year at 4.787% (+2) at 2 p.m.