Triple tailwinds buoy municipal bond prospects

Bottom line up top:

• Policymakers wonder as economic signals waver. There’s a perceptible winter chill in the air amid concerns about the quantity and quality of available economic data. With official statistical releases hampered by delays, private-sector data like last week’s ADP employment survey may carry more weight than usual. ADP reported a startling loss of -32,000 private jobs in November — far below consensus expectations for +31,500 and October’s revised +47,000 gain, and the fourth negative reading in six months. While the survey isn’t known for accurately predicting U.S. Labor Department reports, its recent movements are in keeping with a broader trend of widening cracks in the labor market. This may be enough to convince some U.S. Federal Reserve governors to soften their hawkish stance. Markets are pricing in a high likelihood of a third consecutive 25 basis point (bps) rate cut at this week’s final Fed meeting of 2025 (Figure 1).
• Markets look to stick the landing as year-end approaches. After broadly positive returns for the fourth quarter (and year) to date, investors are now tasked with balancing risk and reward in the closing month of 2025. For equities, the weakening labor market momentum underscores a risk to consumer spending, which could weigh on cyclical sectors. But lower rates — and the resulting boost in liquidity — should support growth and interest-sensitive sectors, especially once investors gain more clarity around fiscal and monetary policy. In fixed income, yields — especially on shorter maturities — face continued downward pressure, while longer-duration bonds may regain some appeal if inflation shows signs of moderating.
  
  Risk appetite outside traditional markets also appears to be rebounding. For speculative-asset investors, a more dovish Fed could spark renewed flows, potentially increasing correlations between equity performance, credit spreads and even digital assets. Cryptocurrency markets, for example, are catching a bid after a mid-November selloff, as sentiment is lifted by rate cut expectations and the easing of worst-case-scenario macro fears.
  
  In general, we’re still constructive on key asset classes we’ve long favored as strategic allocations. Municipal bonds are a prime example, offering sound fundamentals, diversification advantages and attractive yields — accompanied by especially compelling supply and demand technicals as we look ahead to 2026.

Portfolio considerations

After underperforming other fixed income segments this year, the municipal bond market is at an inflection point. Multiple tailwinds are converging to position the asset class well for 2026:

• Vast amounts of investor cash are available. $7.5 trillion sits idle in money market funds, generating lackluster returns. For investors in the 24% federal income tax bracket, after-tax yields on 1- to 3-month Treasury bills have dipped below 3% for the first time since 2022. And with additional rate cuts expected, T-bills and the money market funds that hold them will likely see yields decline further. This could provide a catalyst for what we would classify as a “great rotation” from cash and cash equivalents into municipal securities. Municipals offer relatively safe, high-quality investments with an average credit rating of AA/Aa2, along with historically favorable yields. We anticipate spreads will compress amid investor inflows and stable credit conditions, sustaining municipal bond prices.
• Robust demand, meet ample supply. Heavy issuance has been the talk of the municipal market for the past couple of years and is expected to remain strong, with $600 billion in anticipated new supply in 2026, up from $550 billion in 2025. Meanwhile, principal redemptions and coupon payments are projected to surge 50% next year, creating powerful reinvestment inflows from prior issuance and a wave of refinancing opportunities as rates decline. We expect elevated supply in both the airport and health care sectors, fostering positive conditions for capturing additional yield — though careful security selection is warranted. We also favor state and local government issuers, as well as water/sewer and electric utilities.
• Discounted entry fees. Longer-dated municipal bonds offer their most attractive entry point in more than two years. Consider the 20 year muni bond, which offers yield pickup of +1.45% and +1.12% versus its 5- and 10-year counterparts (Figure 2). We believe this steepness will compress, which should reward strategic positioning along the muni curve.

In our view, these three tailwinds — combined with disciplined credit analysis and active management — may support compelling tax-advantaged, risk-adjusted returns for municipal bond investors.

Nuveen's Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.

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