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Muni ETFs offer attractive tax-efficient yields with low default risks.
Stable credit trends and easing policy fears may support muni ETFs in 2026.
Cooling rate hike fears could improve demand for long-duration muni bonds.
Municipal bonds struggled in the first half of 2025, especially at the long end of the yield curve, before staging a strong rebound in the second half. iShares National Muni Bond ETF (MUB - Free Report) has added 2.6% over the past year while iShares 20+ Year Treasury Bond ETF (TLT - Free Report) has fallen 1.1% over the past year (as of May 8, 2026).
Shorter-term munis showed the opposite trend, outperforming earlier in the year before cooling later on. JPMorgan Ultra-Short Municipal Income ETF (JMST - Free Report) has added about 0.3% over the past year.
Steep Yield Curve Boosts Appeal
The muni yield curve remains historically steep. Twenty-year AA-rated municipal bonds currently offer yields of 4.20%, compared with the ICE BofA AA US Corporate Index Effective Yield of 4.88%, as of May 8, 2026. Because they are backed by municipalities, these bonds have lower default risks than corporate bonds. This steep curve could create opportunities for investors seeking higher tax-efficient income.
Decent Credit Conditions
Muni credit conditions remain resilient, with year-to-date defaults down roughly 70% year over year, as mentioned in an Invesco article. Defaults are expected to remain limited in 2026, per the same article.
First-time payment defaults in March totaled just $49.5 million, representing a steep 79% year-over-year decline. These defaults were concentrated in a single borrower. The March figure also brought year-to-date defaults down to $257.2 million — a 70% decline year over year, the Invesco article revealed.
S&P has upgraded more municipal credits than it has downgraded for 18 straight quarters, while default rates remain historically low, per a Morgan Stanley article. Most municipal sectors currently carry stable outlooks.
Municipal bonds continue to look attractive versus other fixed-income assets on both an after-tax yield and relative-value basis. Taxable-equivalent muni yields remain competitive against investment-grade corporates, Treasurys and even some high-yield sectors, per the same Morgan Stanley article.
Longer-maturity AAA-rated munis also appear inexpensive relative to Treasurys compared with historical averages, while AA-rated munis look cheap across most maturities relative to comparable corporate bonds.
Impact of Middle East Tensions
The Middle East conflict has already affected financial markets by lifting inflation expectations and pushing interest rates higher. Rising energy prices have fueled inflation concerns globally and increased rate volatility.
While financial conditions have tightened, there are no clear signs of severe liquidity stress yet, per the Invesco article. However, the longer-term impact on economic growth remains uncertain.
Elevated inflation could pressure central banks to keep policy tight, although slower growth and weaker labor markets may limit their ability to hike rates further. Overall, central banks are in a tight spot right now, and the market is less likely to see rate hikes in the near term.
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Will 2026 be a Year of Muni Bond ETFs?
Key Takeaways
Municipal bonds struggled in the first half of 2025, especially at the long end of the yield curve, before staging a strong rebound in the second half. iShares National Muni Bond ETF (MUB - Free Report) has added 2.6% over the past year while iShares 20+ Year Treasury Bond ETF (TLT - Free Report) has fallen 1.1% over the past year (as of May 8, 2026).
Shorter-term munis showed the opposite trend, outperforming earlier in the year before cooling later on. JPMorgan Ultra-Short Municipal Income ETF (JMST - Free Report) has added about 0.3% over the past year.
Steep Yield Curve Boosts Appeal
The muni yield curve remains historically steep. Twenty-year AA-rated municipal bonds currently offer yields of 4.20%, compared with the ICE BofA AA US Corporate Index Effective Yield of 4.88%, as of May 8, 2026. Because they are backed by municipalities, these bonds have lower default risks than corporate bonds. This steep curve could create opportunities for investors seeking higher tax-efficient income.
Decent Credit Conditions
Muni credit conditions remain resilient, with year-to-date defaults down roughly 70% year over year, as mentioned in an Invesco article. Defaults are expected to remain limited in 2026, per the same article.
First-time payment defaults in March totaled just $49.5 million, representing a steep 79% year-over-year decline. These defaults were concentrated in a single borrower. The March figure also brought year-to-date defaults down to $257.2 million — a 70% decline year over year, the Invesco article revealed.
S&P has upgraded more municipal credits than it has downgraded for 18 straight quarters, while default rates remain historically low, per a Morgan Stanley article. Most municipal sectors currently carry stable outlooks.
Per Sara Press, the head of high-grade municipal bond research at Goldman Sachs, municipal debt growth has lagged the GDP, revenue and income growth over the past two decades, making debt burdens more manageable for states and local governments than before the 2008-09 downturn.
Attractive Relative Value
Municipal bonds continue to look attractive versus other fixed-income assets on both an after-tax yield and relative-value basis. Taxable-equivalent muni yields remain competitive against investment-grade corporates, Treasurys and even some high-yield sectors, per the same Morgan Stanley article.
Longer-maturity AAA-rated munis also appear inexpensive relative to Treasurys compared with historical averages, while AA-rated munis look cheap across most maturities relative to comparable corporate bonds.
Impact of Middle East Tensions
The Middle East conflict has already affected financial markets by lifting inflation expectations and pushing interest rates higher. Rising energy prices have fueled inflation concerns globally and increased rate volatility.
While financial conditions have tightened, there are no clear signs of severe liquidity stress yet, per the Invesco article. However, the longer-term impact on economic growth remains uncertain.
Elevated inflation could pressure central banks to keep policy tight, although slower growth and weaker labor markets may limit their ability to hike rates further. Overall, central banks are in a tight spot right now, and the market is less likely to see rate hikes in the near term.