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MARKETS
18 March 2025

Weekly Municipal Monitor—Recessions and Munis

By Sam Weitzman
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Macros, Markets and Munis

Munis posted negative returns last week as Treasury yields moved 6 to 16 basis points (bps) higher due to a greater consensus taking shape that the Federal Reserve (Fed) will be unlikely to cut rates this week or during its May meeting. Muni yields moved higher in sympathy with Treasuries but outperformed over the week. Risk sentiment remained weak amid ongoing tariff rhetoric and growth concerns. From an economic data perspective, January job openings came in higher than expected, the February Consumer Price Index (CPI) came in below expectations and declined to 2.8%, and consumer sentiment data moved lower. Meanwhile, muni demand turned negative following seven consecutive weeks of inflows. This week we highlight historical municipal market reactions to recessionary environments.

Demand Weakens as Funds Post Outflows

Fund Flows (down $373 million): During the week ending March 12, weekly reporting municipal mutual funds recorded $373 million of net outflows, according to Lipper. Long-term funds recorded $425 million of outflows, intermediate funds recorded $30 million of inflows and high-yield funds recorded $107 million of inflows. Last week’s outflows broke a seven-week streak of inflows and led year-to-date (YTD) inflows lower to $10 billion.

Supply (YTD supply of $103 billion; up 41% YoY): The muni market recorded $11 billion of new-issue supply last week, down from the prior week. YTD, the muni market has recorded $103 billion of new issuance, up 41% year-over-year (YoY). Tax-exempt and taxable issuance are each up 41%, though tax-exempt issuance has comprised the vast majority (95%) of YTD supply. This week’s calendar is expected to tick lower but remain elevated at $10 billion. The largest deals include $3 billion Dormitory Authority of the State of New York and $1.1 billion Metropolitan Transportation Authority transactions.

This Week in Munis: Recessions and Munis

Recession fears spiked last week as tariff policy and austerity measures drew concern across markets. Equities sold off amid the risk-off sentiment, with the S&P 500 falling 3.9% YTD and the Nasdaq falling 6.1% YTD. Notably, the Atlanta Fed GDPNow indicator declined to as low as -2.8% to start the month, marking the lowest level since the 2020 pandemic drawdowns.

Exhibit 1: Federal Reserve Bank of Atlanta GDP Forecast
Federal Reserve of Atlanta GDP Forecast
Source: Federal Reserve Bank of Atlanta. As of 14 Mar 25. Select the image to expand the view.

Over the past five recessionary periods, municipals have exhibited attractive risk-adjusted performance compared to equities. When comparing the returns of the Bloomberg Municipal Bond Index to the S&P 500 Index, municipals posted positive returns on average (+7.2%), while equity returns delivered average negative returns (-1.2%). Meanwhile, the maximum drawdown for equities over these periods was 35%, compared to the -1.9% return for the Bloomberg Municipal Bond Index, highlighting the potential for relative stability and resilience of municipal bonds during economic downturns.

Exhibit 2: Performance During Prior Recessions (1981-2020)
Performance During Prior Recessions (1981-2020)
Source: Bloomberg, NBER, Western Asset. As of 14 Mar 25. Muni: index returns represented by the Bloomberg Muni Bond Index. Equity: index returns represented by the S&P 500 Index. Recession scenarios defined as follows—1980: January to July; 1981: July to November 1982; 1990: July 1990 to March 1991; 2001: March 2001 to November 2001; 2007: December 2007 to June 2009; 2020: February 2020-April 2020. Select the image to expand the view.

Current muni valuations versus volatile equity counterparts further add to the risk-adjusted value proposition. Considering the Bloomberg Municipal Bond Index starting yield levels, taxable-equivalent income opportunities of 6%-8% offered by munis are presently near long-term equity return levels of 7.7%. This is particularly compelling given that since 2000 the volatility of the S&P 500 Index (15.25%) was more than three times that of the Bloomberg Municipal Bond Index (4.68%). All told, we anticipate the risk-adjusted value proposition to remain supported by favorable fundamental and technical factors, as state and local revenues and reserve balances remain at elevated levels. Meanwhile, we anticipate that demand could also improve should the Fed continue its cutting of short-term rates, making cash solutions less attractive relative to the longer-term after-tax opportunities offered by munis.

Exhibit 3: Muni Taxable-Equivalent Yields Have Approached Long-Term Equity-Like Return Levels
Muni Taxable-Equivalent Yields Have Approached Long-Term Equity-Like Return Levels
Source: Bloomberg, S&P. As of 28 Feb 25. Long-term equity return: S&P 500 Index annualized monthly returns from 01 Jan 00 to 28 Feb 25. Bloomberg indices considering the highest marginal tax rate of 40.8%—National: Bloomberg Municipal Bond Index. CA: Bloomberg California Municipal Bond Index. NY: Bloomberg New York Municipal Bond Index. Yield-to-worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. Select the image to expand the view.

Municipal Credit Curves and Relative Value

Exhibit 4: Muni Credit Curves
Muni Credit Curves
Source: Bloomberg, Western Asset. As of 14 Mar 25. Bloomberg Valuation Service (BVAL) Municipal Credit Indices (AAA, AA, A, BBB, respectively) and US Sovereign Curves. Taxable-Equivalent Muni Credit Curves consider the top marginal effective tax rate of 40.8%. AA Muni is represented by the US General Obligation AA Muni BVAL Yield Curve. The BVAL curve is populated with pricing from uninsured AA General Obligation bonds. A Muni is represented by the US General Obligation A Muni BVAL Yield Curve. The BVAL curve is populated with pricing from uninsured A General Obligation bonds. BBB Muni is represented by the US General Obligation BBB Muni BVAL Yield Curve. The BVAL curve is populated with pricing from uninsured BBB General Obligation bonds. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.
Exhibit 5: Taxable-Equivalent Muni Credit Curves
Taxable-Equivalent Muni Credit Curves
Source: Bloomberg, Western Asset. As of 14 Mar 25. Bloomberg Valuation Service (BVAL) Municipal Credit Indices (AAA, AA, A, BBB, respectively) and US Sovereign Curves. Taxable-Equivalent Muni Credit Curves consider the top marginal effective tax rate of 40.8%. AA Muni is represented by the US General Obligation AA Muni BVAL Yield Curve. The BVAL curve is populated with pricing from uninsured AA General Obligation bonds. A Muni is represented by the US General Obligation A Muni BVAL Yield Curve. The BVAL curve is populated with pricing from uninsured A General Obligation bonds. BBB Muni is represented by the US General Obligation BBB Muni BVAL Yield Curve. The BVAL curve is populated with pricing from uninsured BBB General Obligation bonds. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.
Exhibit 6: AAA Munis vs. Treasuries
AAA Munis vs. Treasuries
Source: Muni Yields: Thomson Reuters MMD, Treasury Yields: Bloomberg. As of 14 Mar 25. Past performance is not a guarantee of future results. It is not possible to invest directly in an index. Select the image to expand the view.
Exhibit 7: Tax-Exempt and Taxable Muni Valuations
Tax-Exempt and Taxable Muni Valuations
Source: Bloomberg, Western Asset. As of 14 Mar 25. Yield-to-worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. AAA, AA, A, BBB Corporate Indices; After-Tax Yield assumes a top effective tax rate of 40.8%. Taxable Muni Index Corporate comparable used is the Global Corporate Aggregate (ex. BBB) to better align credit quality and duration. Select the image to expand the view.

Western Asset Key Themes for Muni Investors

Theme #1: Municipal taxable-equivalent yields and income opportunities remain above decade averages.

Exhibit 8: Muni and Taxable-Equivalent Muni Yield-to-Worst
Muni and Taxable-Equivalent Muni Yield-to-Worst
Source: Bloomberg, Western Asset. As of As of 14 Mar 25. Bloomberg Municipal Bond Index yield considering highest marginal tax rate of 40.8%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

Theme #2: The muni curve has steepened, offering better value in intermediate and longer maturities.

Exhibit 9: AAA Municipal vs. Treasury Yield Curves
AAA Municipal vs. Treasury Yield Curves
Source: Bloomberg, Western Asset. As of 14 Mar 25. Bloomberg Valuation Service (BVAL) AAA Muni Curve and US On-/Off-the-Run Sovereign Curve. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

Theme #3: Munis offer attractive after-tax yield pickup versus longer-dated Treasuries and investment-grade corporate credit.

Exhibit 10: Municipal vs. Taxable Fixed-Income Yields by Quality
Municipal vs. Taxable Fixed-Income Yields by Quality
Source: Western Asset, Bloomberg. As 14 Mar 25. 10- and 30-Year comparison reflects Bloomberg Valuation Service (BVAL) AAA Muni Curve and US On-/Off-the-Run Sovereign Curve. AA Muni reflects the Bloomberg AA Muni Bond Index. A Muni reflects the Bloomberg A Muni Bond Index. BBB Muni reflects the Bloomberg BBB Muni Bond Index. HY Muni reflects the Bloomberg High Yield Muni Bond Index. AA Corp reflects the Bloomberg AA Corporate Bond Index. A Corp reflects the Bloomberg A Corporate Bond Index. BBB Corp reflects the Bloomberg BBB Corporate Bond Index. After-tax yield considers top marginal tax rate of 40.8%. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. Select the image to expand the view.

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