Investors pulled $1.814 billion from municipal bond mutual funds in the week ending Wednesday, breaking a 21-week streak of inflows, according to LSEG Lipper data. This outflow followed $206.4 million in inflows the prior week. High-yield funds were particularly affected, seeing outflows of $583.6 million, compared to $166.2 million the previous week.
The municipal bond market experienced a correction in the short end, with muni yields cut up to 10 basis points for maturities three years and in. In contrast, longer yields increased by one to four basis points. This front-end weakness is attributed to the jump in the two-year US Treasury yield post-Federal Reserve actions and the catching up of floaters to higher trading levels, as noted by Kim Olsan, senior fixed income portfolio manager at NewSquare Capital.
Several high-grade, front-end municipal bonds traded at significant concessions. Examples include Maryland general obligation bonds 5s of March 2027 at 3.001% (+23bps), Florida Board of Education PECO 5s of June 2027 at 2.87% (+10bps), and Loudoun County, Virginia, GO 5s of December 2027 at 2.896% (+13bps).
Kevin McGuigan, director at Municipal Market Analytics, explained that the front-end cheapening follows Wednesday’s bear flattening of the US Treasury curve due to Federal Reserve rate hikes and an implied further hike before year-end. He added that the muni curve remains significantly steeper than the US Treasury curve, with the municipal 2/10 spread at 87 basis points versus 26 basis points for US Treasuries. This dynamic reflects increased expectations for higher-for-longer front-end rates and confidence that tighter monetary policy will control longer-term inflation, contributing to the municipal yield curve's flattening.
Separately, the Schwab Municipal Bond ETF, a $3.6 billion fund, is on track for its largest monthly outflow ever, with investors pulling over $530 million so far in September, including a record $360 million single-day withdrawal. This follows a broader fixed-income selloff that pushed muni yields to multi-month highs. Some analysts, like Eric Balchunas of Bloomberg Intelligence, suggest that large outflows from this ETF might be due to model-portfolio rebalancing by institutional holders, given Schwab's ownership of over 50% of the ETF's outstanding shares. This aligns with comments from Jason Diefenthaler of Schwab Asset Management, who noted that the recent increase in tax-exempt yields creates opportunities for investors and model providers to reposition portfolios.
