Municipals Thoughts from the Municipal Bond Desk

Tim: Let’s talk about supply and demand in the muni market. Has anything changed from what you were expecting earlier this year?

Mark: Great question, Tim. Supply is still running at record levels this year, but the big shift is on the demand side, which has been stronger than many had originally expected. Some are predicting approximately $200 billion of new money flowing into muni bond funds, ETFs, and separately managed accounts over the course of 2026.¹ That kind of inflow could add about $50 billion in net growth to the muni market.¹ On the supply side, I’m still expecting around $600 to $625 billion in issuance to come to market, largely driven by energy-related and housing deals.¹ The bottom line is that with more buyers competing for bonds, muni prices could benefit, which could be a positive setup for investors who are already in the market or looking to get in.¹

Tim: You mentioned energy deals. Let’s dig into pre-paid gas muni bonds specifically. What makes them interesting for investors compared to traditional munis?

Mark: Pre-paid gas bonds—or “prepays”—are a type of muni bond that could potentially be a fit for certain investors who want exposure to corporate institutions while earning tax-exempt income. They aren’t your traditional muni bond, in that they aren’t the obligation of the participating municipal utility, but a corporate institution, which issues the bond through a special purpose entity. More than 90% of these institutions are large banks and insurers.² Prepays tend to carry investment grade ratings,³ while typically paying a higher yield than other investment grade munis. For example, the Bloomberg gas prepay index yielded 3.88% at the end of May, as opposed to the general obligation index’s yield of 3.46%. Year to date, the prepay index has averaged a 42-basis-point yield advantage over general obligation bonds.³ Another consideration for prepays is the fact that many are structured with built-in safety features called termination payments. In plain terms, if the energy deal falls through or the supplier runs into trouble, investors get their money back at par or possibly even a bit more. That’s a layer of protection you don’t always see in munis.

Tim: The broader economy has slowed, but the credit quality of muni bonds still looks solid. Are you seeing the same thing?

Mark: Absolutely. The pace of credit upgrades has cooled from the boom we saw a couple of years ago, but the trend is still heading in the right direction, with more muni credits being upgraded than downgraded.⁴ So far in 2026, there have been about 425 ratings upgrades compared to roughly 365 downgrades, for a ratio of 1.17:1.³ Interestingly, the total dollar value of downgrades is higher this year, but that’s mostly a result of the impact of the Los Angeles wildfires on a limited number of issuers — not because muni credit is weakening across the board.⁴ I think that looking at the number of upgrades versus downgrades gives you a clearer picture of overall credit health than looking at dollar amounts alone, because one or two very large downgrades can skew the numbers. The big takeaway is that the fundamentals behind most muni bonds remain strong. Many state and local governments have been managing their finances carefully, which puts them in a good position to handle future borrowing for roads, schools, and other long-term projects.⁵

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