The broad sell-off in U.S. financial markets has put even more pressure on a municipal bond sector that was already off to a rough start in 2025, leaving investors with on-paper losses in a corner of their portfolios considered relatively safe. The iShares National Muni Bond ETF (MUB) and Vanguard Tax-Exempt Bond ETF (VTEB) — the two biggest municipal bond ETFs — fell 2.8% and 2.6%, respectively, between President Donald Trump’s April 2 tariff announcement and Tuesday’s market close. That’s bigger than the 1.2% drop for the broader bond market, as measured by the iShares Core U.S. Aggregate Bond ETF (AGG) . One broad muni market index on Monday had its worst drop in 31 years, according to Bloomberg . That slump has widened a performance gap from the first quarter, when municipal bonds were already lagging other fixed income bets. Municipal bonds, which are backed by state and local governments, are generally seen as one of the safer fixed income assets. They also pay out interest that is free of federal taxes — and exempt state levies if investors reside in the issuing state — making the group an attractive safe haven for investors. Muni bonds and economic worries Bond prices and yields move in opposite directions to one another. The drop in value for munis comes at a time when investors are looking for a place to hide from the Trump administration’s aggressive trade policy. While the brewing trade war does not involve the municipal bond market directly, concerns about the U.S. economy could be hurting confidence in the sector. “Continued tariffs and a slowing economy would likely impact municipal issuers’ ability to raise revenues, especially those state and local governments whose economy (employment/GDP) may be more reliant on foreign trade or the federal government … Any factor restricting an issuer’s revenue-raising capability will likely weaken its credit fundamentals,” Jeannine Lennon, municipal strategist at UBS, said in an April 8 note. However, recession fears alone can’t explain the broader divergence between munis and other types of bonds. Dan Close, head of municipals at Nuveen, said the sector is currently in a seasonally weak period due to its retail-heavy investor base filing tax returns. He also said issuance of new municipal bonds was up 15% in the first quarter. “When you have such a divergence and you’re trying to hedge your exposure, and munis are losing value and Treasurys — which you’re shorting or hedged against — are going up in value, it’s just really difficult for the broker dealer community to provide liquidity,” Close told CNBC. The approaching tax policy debate Another concern for municipal investors is the looming tax debate in Washington, D.C. Worries about the fate of munis’ tax exemption cropped up when several news outlets reported that removing this benefit could be one of roughly 200 options for reducing government spending in a document that appeared to be from the House Budget Committee. Discussions around a new tax bill are ongoing on Capitol Hill, but there does not currently appear to be any pointed push to remove the tax exemption on these bonds. “This is one of those things that is always going to be part of the conversation. It’s been there every other time we’ve talked about tax changes going back decades,” said Paul Malloy, head of U.S. municipals at Vanguard. Congress has narrowed the scope of the exemption in the past, which could be one option on the table this time. Tom Kozlik, head of public policy and municipal strategy at Hilltop Securities, said in an April 8 note that the bonds already on the market would likely be unaffected by a tax policy change. To be sure, the abnormally large drop in municipal bond prices means that the yields available for investors are getting closer to those of Treasurys, even before considering the tax benefits. Malloy said this could prove to be a “really attractive entry point” but added that investors should use diversified funds, or even active products like Vanguard Tax-Exempt Bond ETF (VCRM) , to try and limit the damage a recession would cause to any particular locality or bond issuance. “Regional and geographic differences are part and partial to municipal investing. It goes back to why it’s really necessary to be in some sort of commingled vehicle. … This is where our research analysts really earn their keep,” Malloy said.
