By Patti Domm

Muni bonds have a lot going for them right now, and their tax-free status makes them all the more appealing for some investors.

BlackRock says in its fourth quarter outlook that the sector is "firing on all cylinders" and the market is expected to continue to deliver positive returns. September's monthly performance was the best since December 2023.

While bond strategists are positive, they also note there are areas of uncertainty in the $4.3 trillion market. Much of that is coming from Washington's fiscal and policy changes.

Shannon Rinehart, Columbia Threadneedle's co-head of municipal investments, says the muni market is fundamentally strong, though its performance has lagged behind other parts of the fixed-income market this year.

"When you actually look at the underlying fundamentals, when you look at reserves, when you look at some of the work states have done on their pension obligations, the muni market is still extremely high quality," she said.

Still, there are long-term worries. "There is just a sizable shift in terms of fiscal responsibility that is moving from the federal government to the states," Rinehart said. "It is still to be determined how the states are going to respond to those spending cuts."

California, for instance, may see its credit downgraded, Rinehart said. California hasn't shown the will to cut spending ahead of anticipated reductions in federal funds. Moody's rates the state AA, and it could be reduced to A, Rinehart noted.

Other states may take a blow from Medicaid cuts. President Donald Trump's signature policy legislation passed this summer slashed $900 billion from Medicaid spending over 10 years.

Medicaid funding is "passed through to the recipients and hospitals," Rinehart said. States will be forced to decide whether to cut coverage or find alternative revenues to cover it. "The reality is that's happening on a lot of fronts. It's not just Medicaid." States are also expecting to receive less disaster assistance from the Federal Emergency Management Agency.

That may be an issue for munis. Investors have seen the federal government as a backstop for municipal issuers when natural disasters like hurricanes or wildfires hit.

The highest rated 10-year municipal issues have yielded about 2.78% for the month of October, a ratio of 70% to Treasuries, according to Columbia Threadneedle. Munis usually yield less than Treasuries because they are tax-exempt.

Strategists say municipal bonds performed better following the passage of the One Big Beautiful Bill Act. Cooper Howard, fixed income strategist at Charles Schwab, said 2025 has been a "tale of two halves" for the muni market.

Before the bill was passed in July, there was speculation there could be changes to the tax exempt status on municipal issues. That hurt sentiment and spurred a rush of issuance that weighed on the market, he said.

At $429 billion year to date, municipal debt issuance is 60% higher than issuance at the same time in 2023, he added. The pace of new issues has since slowed.

Howard said he sees opportunities in the intermediate and longer-term durations.

"In the muni market, a good starting point is about six to seven year [duration]." He said he is cautious on hospitals because of the Medicaid impact.

"This isn't going to be a tomorrow story. This is a story that's going to take years to develop," Howard said. "The other piece I'd be more cautious on would be some higher education issues. They have demographic issues."

The high cost of college is deterring some students from higher education. Schools that depend on international students could also be impacted.

Rinehart said she found good value in Texas school bonds issued this past summer by school districts but backed by the state. For instance, Forney Independent School District issued 30-year bonds to yield 5.03% They were yielding 4.29% this week. Yields move opposite price.

School districts in the state rushed to issue new debt this summer ahead of a change in tax laws that impacted the amount of revenue school districts could borrow against.

Rinehart said she also sees opportunity in prepaid gas deals. "That offers a nice opportunity to diversify risk because the underlying credit risk is actually from the financer," she said. A prepaid gas deal is a long-term contract that a municipal entity enters with a financial services firm. The firm receives the cash up front and is obligated to deliver energy to the municipal utility company.

Such deals have "enabled us to get exposure to a new sector that otherwise isn't issuing in our market," said Rinehart. "They are intermediate by nature so you're hitting the natural demand pocket in our market and they're high quality." She said many of the deals have come with spreads of 100 basis points or more over muni yields. A basis point is 0.01 percent.

Goldman Sachs, for example, brought a California Community Choice prepay to market with Pacific Life Insurance as the funding recipient. It was yielding 4.5% when issued in June and its yield has since fallen by 82 basis points.

BlackRock expects to see continued demand for munis.

"We foresee demand for munis ticking up near-term spurred by positive performance, attractive valuations, and moderating supply as policy-driven issuance wanes, and issuers gain visibility into the path of monetary policy normalization," notes Pat Haskell, who heads BlackRock's municipal bond group.

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October 20, 2025 14:06 ET (18:06 GMT)

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