Key Takeaways
- Recent volatility has reset municipal yields higher, strengthening return potential and relative value while fundamentals remain intact.
- Growing supply and wider credit dispersion are creating clear winners and losers, reinforcing the value of active, research‑driven security selection.
- We see potentially compelling opportunities by emphasizing yield‑curve positioning, bank retrenchment, and selective investments in healthcare and Continuing Care Retirement Communities (CCRCs).
The municipal market has undergone a meaningful reset, which may improve after‑tax return potential for investors. Higher U.S. Treasury yields tied to geopolitical uncertainty – combined with increased interest‑rate volatility, seasonal tax‑related selling, and shifting supply dynamics –have driven a broad repricing. In March, benchmark AAA municipal yields rose 28–60 basis points across the curve,1 with most of the move concentrated in the latest bout of volatility.
The reset has tangible implications. The yield‑to‑worst on the Bloomberg Municipal Bond Index now stands at 3.77%2– or 6.38%3 on a taxable‑equivalent basis – placing it in the 93rd percentile relative to the past 15 years. Higher starting yields can provide a stronger foundation for forward returns, and after‑tax outcomes.
Relative value has improved as well. On a taxable‑equivalent basis, investment‑grade municipals are currently offering almost 270 basis points over cash4 and about 120–220 basis points over comparable taxable fixed‑income alternatives.2 This environment reinforces PIMCO’s long‑standing view that municipals may represent one of the most compelling public market opportunities for U.S. taxpayers on a tax‑ and default‑adjusted basis. The recent reset higher in yields has only strengthened that case over the longer term (Figure 1).
PIMCO views periods of elevated volatility as opportunities, and the recent repricing may offer an attractive entry point for investors. This view is supported by our constructive outlook on U.S. duration, as the energy shock introduces downside risks to growth, with the U.S. economy appearing particularly vulnerable given an already softening labor market. In addition, with tax‑exempt markets now negative year‑to‑date, investors evaluating their tax situation may find timely opportunities for tax‑loss harvesting.
Looking ahead, a shifting supply backdrop, widening credit dispersion, and emerging stress in the lower‑quality segments of the market underscore why disciplined security selection continues to be important. In this environment, disciplined portfolio management, robust and integrated investment resources, and a strategic, selective approach can help investors navigate challenges while seeking to position portfolios for resilience and opportunity.
Figure 1: PIMCO Capital Market Assumptions
As of December 2025. SOURCE: PIMCO. For illustrative purposes only. Figure is not indicative of the past or future results of any PIMCO product or strategy. There is no assurance that the stated results will be achieved.
1For indices and asset class models, return estimates (arithmetic) are based on the product of risk factor exposures and projected risk factor premia which rely on fair value models and qualitative inputs from senior PIMCO investment professionals. Returns for the BBG Muni and the BBG HY Muni are reported on a tax-equivalent basis assuming a 40.8% to marginal tax rate (37% federal and 3.8% Affordable Care Act tax rate).
Shifting issuance trends
Supply reached record levels in 20255 and is expected to remain elevated, driven by infrastructure investment and deferred maintenance, both influenced by inflation and supported by prior legislation. Also, as pandemic‑era stimulus rolls off in 2026 and municipalities seek to maintain healthy reserve levels, issuers will continue to turn to debt markets.
Current projections for 2026 estimate gross municipal issuance is between $525 billion and $600 billion, well above the post global financial crisis average of about $417 billion (Figure 2). However, net issuance should be modestly more supportive than in 2025, while current valuations indicate one of the most attractive forward-looking return environments in the last decade.
Figure 2: Annual Municipal Supply
Source: Bond Buyer, J.P Morgan Research, Barclays as of 31 December 2025
*Estimate
AI infrastructure and supply
The AI investment cycle has boosted capital spending on data center development and increased issuance in both public and private taxable markets, but it has not yet translated into higher municipal issuance.
Data centers have more than doubled their share of U.S. electricity consumption over the past five years, and current projections anticipate continued long-term growth. Before the data-center boom, the public power sector was already expected to enter its next investment cycle to develop firm capacity. However, issuers have been cautious about aligning capacity additions with current forecasts given the significant uncertainty over the pace and magnitude of data center load growth, likely to result in continued reliance on private‑sector financing.
Sound credit fundamentals
State and local credit fundamentals today remain sound, revenue collections are stable and materially higher than five years ago6, while total balances – including rainy day reserves – are still near historically elevated levels.7 The exhaustion of pandemic-era federal relief funds is a notable development and likely to increase dispersion across issuers as deficits emerge. Some have already experienced downgrades while others are being assigned negative outlooks.
Default risk has historically been low in higher quality segments, as fiscal flexibility remains, but active credit selection is becoming increasingly important.
One Big Beautiful Bill in effect
State governments: Changes to Medicaid are anticipated to be a headwind for further state credit upgrades, as the program accounts for roughly 30% of state budgets. However, states benefit from discretion in managing their plans and will likely implement a combination of their own cuts and replacing a portion of lost federal revenue. We expect many states will run budget deficits as they intentionally spend down reserve levels that remain far above historic norms, with many using those funds for one-time projects.
Healthcare: Projected Medicaid spending cuts, along with the accelerated phase-in of work requirements by the end of 2026, are expected to pressure some healthcare systems. Potential revenue declines are estimated to be 1%–3% but could be bigger depending on exposure to government payers. Larger, multi-site systems should benefit from integrated operations and strong liquidity, while smaller, single-site providers with high government-payer exposure are more likely to face challenges.
Higher education: The bill enacts a tiered excise tax on private university endowments but raises the exemption threshold from 500 to 3,000 students, significantly reducing the number of affected institutions and mitigating the impact on smaller universities. While modestly negative for universities with large endowments, these institutions benefit from strong demand, good tuition pricing power, and healthy resources.
High yield appears particularly attractive
We remain positive on high‑yield municipals for their potential to offer higher yields and excess return opportunities versus investment‑grade debt. But tight spreads (Figure 3) and elevated default risk in the lowest‑quality segments of the market reinforce the importance of careful security selection and disciplined risk management. Recent headlines and price declines tied to a large speculative‑grade project-finance issuer exemplify these risks, which have emerged alongside the growth of non‑traditional issuers, and newer financing structures.
In our view, historical default data understates today’s risk because it is based mostly on rated bonds, which now make up a smaller share of the market. Also, it doesn’t reflect how much the market has grown both in size and complexity over the past decade. As investors reached for yield between 2016 and 2021, many deals were structured with weaker protections, and those issuers are beginning to experience credit stress. We believe the risk of elevated defaults and lower recoveries may be likely to increase in this segment of the market. As a result, we see value in select, private placements that offer yields in line with – or exceeding – traditional high‑yield opportunities, while benefiting from more resilient credit profiles.
Figure 3: Municipal credit spreads remain near all-time tights
Source: Bloomberg as of 31 March 2026
Investment opportunities: actively identifying value
Municipal bonds continue to stand out as a potentially attractive opportunity, with the potential to offer attractive performance across a range of economic outcomes. Our active approach seeks to deliver above‑index returns without materially increasing risk by capitalizing on bank retrenchment opportunities and identifying value in healthcare and select CCRCs.
Capitalizing on bank retrenchment
As institutional investors have stepped back from municipals over the past 15 years, liquidity has become more uneven – creating both challenges and opportunities in public municipals while private investments have emerged. Through active management and thoughtful, disciplined implementation, we seek to capitalize on this increasingly target‑rich environment.
Liquidity: With broker-dealers holding less inventory and more money sitting in daily‑liquid vehicles8, markets can come under pressure when retail investors rush for the exits. At PIMCO, we structure portfolios with liquidity as a core consideration, dynamically adjusting positioning based on current market conditions and forward expectations to play both defense and offense, aiming to help drive total and risk‑adjusted returns.
Steep curve: Banks have historically been natural buyers of long-end, tax‑exempt bonds, and their retreat – combined with strong retail demand through direct ownership of shorter maturity bonds – has contributed to valuation distortions. Today, yield‑curve positioning is critical, as short and intermediate tax‑exempts appear relatively rich, while longer‑dated municipals may offer compelling value. The 10-year to 30-year slope stands at about 135 bps,1 its steepest level since the taper tantrum. Taking a barbell approach may help add meaningful excess yield without taking on excessive interest‑rate risk, while capturing attractive spread, carry, and roll‑down potential.
Non-traditional, private placements: Banks’ historical role as providers of private tax‑exempt financing has created niche entry points for investors able to access proprietary deal flow. Multi‑family housing represents a meaningful opportunity. These non‑rated, typically privately placed investments are backed by high‑quality assets and may offer tax-free yields of roughly 5.5%–6.5%, providing high‑yield‑like return potential while avoiding lower‑quality credits and may enhance portfolio resilience.
Select opportunities in healthcare and continued care
Leveraging an experienced investment team and integrated platform, we see select opportunities to add spread risk in systems with below‑average Medicaid exposure, supported by resilient volumes and pricing despite modest margin pressure. An aging population may continue to support volume, while consolidation pressures may enhance pricing power and greater use of non‑hospital settings could help limit incremental borrowing needs.
CCRCs are concentrated in the lower‑quality segment of the municipal market, representing approximately 11% of the Bloomberg High Yield Municipal Bond Index.2 Pandemic‑related pressures and sharply higher labor costs made this one of the most challenged sectors from 2020–2024, with default rates averaging roughly 9% annually.9 We have taken a cautious approach to the sector over time, adjusting exposure as conditions evolved. More recently, a repricing of risk alongside strengthening fundamentals has begun to create meaningful opportunities.
Active advantage
Periods of volatility may create opportunities and today the municipal market presents differentiated potential opportunities for active investors. Elevated yields, widening dispersion, and evolving market dynamics are creating a more opportunity‑rich environment – one where careful security selection, liquidity management, and yield‑curve positioning can matter more than ever. In our view, an active, disciplined approach supported by resources spanning public and private markets is well‑suited to help investors navigate complexity while seeking durable, tax‑efficient income and capital appreciation across market cycles.
1TM3 MMD Interactive Data as of 31 March 2026 ↩
2Bloomberg as of 31 March 2026 ↩
3Taxable-equivalent yield calculation assumes a 37% federal income tax and a 3.8% Medicare investment tax. The yield to worst is the yield resulting from the most adverse set of circumstances from the investor’s point of view – the lowest of all possible yields. ↩
4FTSE 3-Month Treasury Bill Index as of 31 March 2026 ↩
5Bond Buyer as of 31 December 2025 ↩
6United States Census Bureau, quarterly summary of state and local taxes, not seasonally adjusted as of 30 September 2025 ↩
7Pew as of 31 December 2025 ↩
8The Federal Reserve as of 30 September 2025 ↩
9Ziegler as of 10 July 2025 ↩
