Can Muni Bond Fundamentals Remain Steady?

The municipal bond market has rebounded from the technical pressures of the first half of 2025 caused by record-setting issuance.¹ As 2026 begins, we believe that municipal fiscal conditions continue to be strong. State budgets for fiscal 2026 overall reflect a healthy environment, and general fund balances remain well above the historical average even as they continue to ease from 2023’s peak. Though state general fund revenue has fallen off the record pace of fiscal 2021 and 2022 as the impact of Covid–era relief waned, it has continued to grow, and modest revenue gains are expected in fiscal 2026. Budgets enacted to date suggest flat general fund spending in 2026, and most states plan to maintain or increase the size of their rainy-day fund—many of which are already at nominal highs—in anticipation of future needs.²

Another sign of fiscal strength can be found in improved pension funding, as the aggregate median ratio for local-government pensions climbed to 80% in fiscal 2024 from 78% in fiscal 2022. While this can be attributed in part to market performance, local governments have increased contributions and tweaked their benefit structures, demonstrating improved funding discipline and better long-term sustainability.³

Overall, muni bond ratings activity has been positive in 2025, but not by much: Positive activity (including both upgrades and favorable outlook revisions) outpaced negative activity at a rate of 1.4x year to date through November.⁴ Both defaults and first-time distressed debt remained very low in 2025.⁵

Muni yields are still attractive relative to their historical averages, in our view, and current dynamics provide particularly favorable conditions managers to uncover attractive opportunities through fundamental, research-driven credit selection.