September’s fixed income sell-off marked a watershed moment for muni bond markets, delivering the steepest drawdown since the 2008 Great Financial Crisis. As benchmark yields spiked, prices across muni ETFs fell in tandem, and the volatility has not let up. This week, both 10-year and 30-year Treasury yields climbed to their highest levels since 2002.
Key Takeaways
- Municipal bonds experienced their steepest pullback in decades, with state and local debt dropping 4.4% in September.
- Municipal bond yields breached historical ratios, offering high-earning taxpayers an attractive tax-equivalent yield of up to 8.75%.
- Muni ETF strategies have gained strong momentum, with national muni benchmarks VTEB and MUB drawing significant net inflows this year.
But this was a rate shock, not a credit crisis. Municipal credit quality remains near record strength, while tax-advantaged yields have climbed to their highest levels in more than a decade. For long-term investors, that pairing of historically cheap valuations and strong credit creates the potential for total returns that compare favorably with equities on a tax-adjusted basis, with significantly less risk.
ETFs, which traded continuously through the turmoil, are one of the most flexible ways to act on it.
September Sell-Off
Rising rates and a broader global bond shakeout sent state and local debt down 4.4% for the month. The benchmark 30-year muni yield climbed to 5.18%, its highest point since at least January 2011.
September’s traditional wave of seasonal issuance was compounded by a powerful new structural catalyst: the AI and data center boom. While tech hyperscalers privately fund their own servers, the massive strain on local resources requires sweeping public utility upgrades. State and local issuers are increasingly tapping the muni market to finance the power, grid, water, and wastewater infrastructure these facilities require.
This flood of new supply met retail-heavy mutual funds experiencing consecutive weeks of net redemptions, with managers forced to sell into a thin secondary market. Unlike open-end funds relying on daily matrix pricing, muni ETFs traded continuously in real time, transparently reflecting market-clearing levels while providing liquid tools for dynamic duration rebalancing.
Fundamentals vs. Valuations: The Disconnect
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Resilient credit strength. State and local governments entered this period with record rainy-day reserves. Default rates remain near zero — historically lower than corporate credit default rates across every rating tier. Over multidecade periods, even munis rated BBB have defaulted less often than corporates rated AAA.
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Stretched ratios. Benchmark municipal-to-Treasury (M/T) yield ratios crossed 75% on the 10-year and 100% on the 30-year, breaching historical averages of ~68% and ~88%. This means tax-exempt munis were temporarily yielding more than taxable U.S. Treasuries.
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Discounts to par. Many intermediate- and long-term issues now trade well below par value. For individual bonds and target-maturity ETFs, that creates a dual return engine: high tax-free income plus built-in appreciation as bonds approach maturity.
The ‘Equity-Like’ Math: Tax-Equivalent Yields
Because muni interest is generally exempt from federal income tax (and often state/local taxes), headline yields understate cash flow value for top-bracket taxpayers. At a 5.18% yield and an assumed 40.8% top federal rate (37% plus the 3.8% net investment income tax), benchmark paper delivers an 8.75% tax-equivalent yield (TEY).
Source: Raymond James (as of 10/5/2026)
On a recent webcast, Nicholas Venditti, senior portfolio manager and head of municipal fixed income at Allspring Global Investments, told me there’s never been a better time to buy.
“On a scale from one to Ryan Reynolds, munis are as sexy as they’ve ever been,” he said. “This is a really interesting time to look at the muni market because you are buying low, you are locking in yields. And I have a hard time believing you will regret locking in a tax-exempt yield a year or two or five years from now in a portfolio.”
Strategic Muni ETFs in Action
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Duration positioning. Institutional investors have heavily favored short-duration and ultra-short active ETFs to anchor liquidity while capturing elevated yields. Broad benchmarks like the iShares National Muni Bond ETF (MUB) continue to lead overall category inflows, while short-duration strategies like the iShares Short-Term National Muni Bond ETF (SUB) offer stable carry with minimal NAV sensitivity.
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Core IG. Heavyweight strategies like the Vanguard Tax-Exempt Bond ETF (VTEB) offer diversified access to high-grade AAA/AA debt, delivering top-tier tax-equivalent yields while holding resilient on a relative NAV basis. VTEB has been the year’s top asset gatherer — bringing in more than $10 billion in net inflows.
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Active execution. Given the vast scope and fragmentation of the municipal market, active ETF managers can exploit secondary market dislocations, mispriced credit upgrades, and new-issue concessions far more dynamically than rigid passive indices. Active strategies such as the Allspring Ultra Short Municipal Income ETF (AUSM) allow managers to dodge credit landmines while maximizing risk-adjusted NAV performance.
Risks: What to Watch For
Credit selection matters, particularly in high yield. “Our credit team is tearing apart these stories on a day-to-day basis to find winners and losers,” said Venditti. “You’re starting to talk about equity-like returns for muni-like risk, but tread with caution because there are a lot of weird things out there like malls in New Jersey and rice husks to IKEA furniture plants.”
Additionally, if Treasury yields continue climbing like they have been this week, longer-duration funds could see further mark-to-market pressure, while heavy infrastructure issuance could keep temporary pressure on prices.
September’s pullback was a classic market dislocation marked by technical selling in what has historically been viewed as a sleepy, defense-first asset class. As a result, muni ETFs today offer a rare risk/reward profile backed by institutional credit quality.
Originally posted on ETF Trends
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