Municipal Bonds: Seizing the Steep Curve Opportunity Amid Tariff Turbulence

The municipal bond market has faced turbulence in recent months, buffeted by tariff-driven macroeconomic uncertainty and spillover effects from a volatile Treasury market. Yet beneath the surface lies a compelling opportunity: rising Muni/Treasury yield ratios and a steepening yield curve have created a unique entry point for investors willing to extend duration in high-quality, intermediate- to long-dated municipal credits. For those in higher tax brackets, the calculus is clear—now is the time to act.

The Yield Differential Play: Value Emerges from Dislocation

The Muni/Treasury yield ratio—a critical gauge of municipal bonds' relative value—has surged to levels not seen since late 2023. As of May 2025, the 10-year AAA municipal yield stands at 3.26%, yielding 75% of the Treasury's return before tax adjustments. For investors in a 37% tax bracket, this translates to a tax-equivalent yield (TEY) of 5.26%, a figure that eclipses the yields of comparable taxable corporate bonds by 100–200 basis points. Meanwhile, the 30-year ratio of 93.9% signals that long-dated munis now offer equity-like returns (e.g., 7.5%–8% TEY for top-tier 20-year AA/A credits) with far less volatility.

The data is stark: . The current spread suggests munis are priced to perfection for near-term risks but offer asymmetric upside as markets stabilize.

The Steepening Curve: Duration as a Weapon, Not a Weakness

The municipal yield curve's steepness has reached extremes, with the 2-to-30-year slope at 162 basis points, nearly double the Treasury curve's 86 bps. This divergence is no accident. Short-dated muni yields have lagged Treasuries, while long-dated munis have surged—20-year AAA yields have climbed 52 bps year-to-date, nearing a decade-high of 4.5%.

The key advantage? The 10-year call feature embedded in most municipal bonds. Extending duration to the 10–20 year segment adds only marginal interest rate risk while capturing an 80-basis-point premium over shorter maturities. For example, a 20-year AA/A bond's yield of 4.5% (TEY ~7.5%) offers 2.25% more yield than a 5-year municipal, with just a 30% increase in duration risk. This is a trade-off even conservative investors can embrace.

Navigating Uncertainty: Quality and Patience

Critics will point to macro risks—tariffs, inflation, and the Federal Reserve's next move. Yet municipal fundamentals remain robust. State and local tax revenues grew 4.5% year-over-year in 2024, underpinning creditworthiness. Default rates for AA/A issuers remain near historic lows, at 0.1%—a fraction of corporate bond defaults.

Even supply pressures—issuance is up 18% year-to-date—do not negate opportunity. The market's fragmented liquidity has widened spreads beyond fair value, creating a “buyers' market” for long-term investors. Pair this with the Fed's hinted rate cuts in 2025, which could further compress yields on short-term instruments, and the case for duration extension grows stronger.

The Strategic Play: Build a Bulletproof Portfolio

Investors should focus on AA/A-rated credits with 10–20 year maturities, leveraging the steep curve while avoiding the tail risk of ultra-long durations. Consider:
- Intermediate maturities (5–15 years): Offer the best balance of yield (4.2%–5.5% AAA) and manageable duration.
- High-yield munis: Spreads over Treasuries have blown out to +167 bps, offering a 4.68% absolute yield (7.91% TEY) with strong cash flows from essential services like water/sewage.

Avoid “reach-for-yield” traps in lower-rated credits or callable securities. Stick to call-protected bonds to lock in current yields.

Conclusion: Act Now—The Clock is Ticking

The combination of elevated Muni/Treasury ratios, a steep yield curve, and tax-advantaged yields has created a once-in-a-cycle opportunity. While volatility may persist in the near term—driven by tariff negotiations and Fed policy—longer-dated munis offer a rare chance to lock in equity-like returns with bond-like risk profiles.

The path forward is clear: allocate to intermediate-to-long-dated AA/A munis, dollar-cost-average through market noise, and hold for the long term. The steep curve isn't just a technical chart—it's a roadmap to outsized returns in an otherwise yield-starved world.

Investors who hesitate risk missing the window. The time to act is now.