Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / How Bull Markets Are Transforming Muni Bonds in 2026
Transcript
- Lucas: So the S&P 500 closed at 7,499 yesterday, small caps just had their best first half in 35 years, and the Nasdaq is up nearly 3% this week alone. It's easy to look at this bull market and think exclusively about equities — but there's a quiet revolution happening in a corner of fixed income that usually gets zero attention. Luna: You're talking about municipal bonds, aren't you? I've noticed a lot of headlines about states refinancing debt. Lucas: Exactly. Municipal bonds, or munis, are debt issued by states, cities, counties, and other local government entities. And right now, they're experiencing a refinancing wave that rivals what we saw in 2020 and 2021. The difference is, back then it was driven by pandemic-era rate cuts. Today, it's the bull market itself creating the conditions. Luna: How so? The Fed funds rate is at 3.63% — that's not exactly low. Lucas: Right, it's not low historically. But compare it to where muni yields were trading in late 2023. At that point, the benchmark aaa rated muni yield was pushing 4.5%. Now it's closer to 3.8%. That's a meaningful compression, and it's driven by demand. Investors are rotating out of equities into bonds to lock in gains, and they want tax-exempt income. So supply is being absorbed quickly, and issuers are taking advantage. Luna: I saw that California just did a $4 billion refunding deal. That's huge. Lucas: That's the big one. California, which is the largest muni issuer in the country, refinanced about $4 billion in outstanding debt at lower rates, saving taxpayers an estimated $300 million over the life of the bonds. And they're not alone. New York, Texas, Illinois — all have been active in the primary market. The volume of refunding issuance this year is up about 40% year-over-year. Luna: And this is all because the bull market has boosted tax revenues, which makes the credits stronger, which lowers yields? Lucas: That's part of it. But there's another factor: the ai driven economic boom is generating massive corporate tax receipts for states like California, Washington, and New York. Those inflows are improving the fiscal outlook for those states, which in turn compresses their credit spreads. So you've got a virtuous cycle — stronger economy, better credit quality, lower borrowing costs, more infrastructure spending. Luna: Infrastructure spending is the other story here. A lot of these new issues aren't just refundings — they're for new projects, right? Lucas: That's where it gets interesting. The traditional muni market is dominated by projects like schools, roads, water systems. But in 2026, we're seeing a surge in what are called 'green muni bonds' — bonds specifically earmarked for renewable energy, climate adaptation, and sustainable infrastructure. The volume of green muni issuance is on pace to exceed $20 billion this year, up from about $12 billion in 2024. Luna: So the bull market is literally funding solar panels on school roofs and EV charging stations. Lucas: Exactly. And there's a fascinating link to the tech sector. Data centers are enormous consumers of electricity. To meet that demand, utilities are building new power plants and upgrading grids. Many of those projects are being financed through municipal bonds issued by public power authorities. So in a roundabout way, the AI boom is helping build new schools and hospitals, because the tax base and the need for infrastructure are both expanding. Luna: But not all munis are created equal. What about the risk of a slowdown? If the bull market falters, tax revenues drop, and those credits could weaken. Lucas: That's the key risk. Muni defaults are historically rare — the cumulative default rate for investment-grade munis over 10 years is less than 0.1%. But during a recession, state and local budgets get squeezed, and some weaker credits can come under pressure. However, right now the overall credit quality is improving. Moody's upgraded the outlook for the US local government sector to positive earlier this year. Luna: So for an individual investor, how do you play this? Buy individual bonds, or ETFs? Lucas: I'd lean toward ETFs for most people. The muni market is vast and fragmented — there are over a million different bond issues. Individual bonds can be illiquid, and you need a lot of diversification. ETFs like MUB or VTEB give you broad exposure to investment-grade munis at a low cost. And if you're in a high tax bracket, the tax-equivalent yield can be very attractive. Luna: Before we go deeper into strategy, I want to take a quick step back. You know, we talk about all these market trends and investing ideas every day on this podcast. And honestly, the reason we can keep doing it ad-free is because of listeners who chip in a couple of dollars a month. It's not a huge ask — but it genuinely makes a difference. If our conversations have helped you think about your portfolio or just understand the market better, consider supporting the show at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. Every bit helps us keep the lights on and the content free. Luna: Yeah, absolutely. It's a small gesture that goes a long way. And we really appreciate it. Lucas: Okay, back to munis. So one trend I think is underappreciated is the rise of 'baby bonds' — smaller, retail-friendly muni issues with $100 or $500 par values instead of the standard $5,000. These are making munis accessible to a broader audience. Luna: And they're often sold directly through platforms like Public or Robinhood, right? That's democratizing access. Lucas: Exactly. But there's a catch — liquidity can be even worse for these tiny issues. You might buy a baby bond at a fair price, but when you go to sell, the bid-ask spread could be painful. So you really need to think of them as buy and hold investments. Luna: What about the tax side? Muni interest is exempt from federal income tax, but what about state taxes? Lucas: That depends on the state. Most states exempt interest from bonds issued within that state. So if you live in California and buy a California muni, you get triple tax-free — federal, state, and sometimes local. But if you buy a bond from another state, you'll owe state income tax on it. For high-income earners in high-tax states, the tax advantage is enormous. Luna: So the classic strategy is to buy your own state's bonds. But in the current environment, with yields compressed, is it still worth it? Lucas: I think so, but you have to be selective. The tax-equivalent yield on a 3.8% muni for someone in the top federal bracket of 37% plus, say, 13.3% California tax, is over 7%. That's competitive with corporate bonds on a risk-adjusted basis. Plus, the credit quality is generally higher. Luna: One thing I've noticed is that muni bond funds have been seeing consistent inflows this year. Is that retail investors, or institutions? Lucas: Both. According to Lipper data, muni bond funds have posted net inflows for 18 consecutive weeks as of late June. That's the longest streak since 2021. Retail investors are chasing yield, and institutions are doing liability-driven investing. The demand is so strong that some fund managers are having trouble finding bonds to buy — they're sitting on cash. Luna: That sounds like a sign of a crowded trade. Is there a risk of a bubble in munis? Lucas: A bubble might be too strong a word, but valuations are certainly rich. The ratio of muni yields to Treasury yields is near historic lows — around 80% for 10-year AAA munis. That means munis are expensive relative to Treasuries. If risk appetite suddenly reverses, munis could underperform. But for a long-term investor in a high tax bracket, the carry is still attractive. Luna: So what's the one thing you'd tell a listener who's never considered munis before? Lucas: If you're in a high tax bracket and you hold bonds in your taxable account, you're probably leaving money on the table by not owning munis. Even a small allocation — say 10% of your fixed income — can boost your after-tax return meaningfully. Just make sure you're diversified and you understand the liquidity profile. Luna: And with the Fed on hold and the bull market broadening out, munis seem like a nice steady complement to all that equity volatility. Lucas: Exactly. It's not the most exciting corner of the market — but sometimes the quietest returns are the most reliable.