Insights for Municipal Investors & Issuers
By Brian Johnson, Director of Investment Services
and Brian Reilly, Senior Municipal Advisor | Managing Director
With summer firmly in the rearview mirror, financial markets are entering the final stretch of the year, balancing a still-healthy economy against inflation pressures that continue to influence interest rate expectations. Those broad forces converged last week as the Federal Reserve’s Federal Open Market Committee (FOMC) increased the target range for the federal funds rate by 25 basis points (0.25%) to 3.75%–4.00%. The decision was unanimous among voting members and represented a shift from an earlier wait-and-see posture.
In a statement released upon conclusion of its September 16th meeting, the FOMC described economic activity as “expanding at a solid pace, supported by resilient domestic spending, strong productivity growth, and robust capital investment.” At the same time, they continued to emphasize that inflation remains elevated above their 2.0% target.
Recent price data helps explain the Fed’s decision to modestly tighten its policy stance. The Consumer Price Index (CPI) rose 0.4% in August, representing a 3.4% increase year over year. Energy remained an important contributor, with gasoline prices rising 3.9% in August. Core CPI, which excludes food and energy, increased 0.3% in August and 2.4% versus one year prior.
A firm labor market gave the FOMC room to keep its focus on price stability and its long-term inflation target. Employers added 162,000 jobs in August, while the unemployment rate held at 4.1%. The August jobs data showed a marked improvement over the revised July number of 21,000 jobs.
Consumer spending has largely driven the U.S. economy over the past several months, and August retail sales data reinforced that trend. Retail and food-service sales increased 1.2% in August and were 6.0% above August 2025 levels, according to a recent U.S. Commerce Department data release.
At the time of this update, the 1-year Treasury yield was 4.39%, the 2-year was 4.68%, and the 10-year yield was just shy of 5.00%. Even after the increase in the fed funds rate, overnight rates still remain meaningfully below short-to-intermediate yields.
For public funds investors, higher yields across yield curve improve the income potential on high-quality fixed-income investments by selectively extending duration. This also provides a higher level of certainty related to interest income when budgeting. It’s true that short-term vehicles such as money market funds and Local Government Investment Pools (LGIPs) continue to offer reasonably attractive yields, which will likely improve nominally as reinvestment in those underlying portfolios unfolds. However, those yields will remain highly sensitive to future FOMC decisions and can change quickly as monetary policy expectations evolve.
We believe cash-flow forecasting remains the foundation of an effective investment strategy. Clearly identifying operating liquidity, near-term expenditures, and funds that can be invested beyond immediate needs can help governmental entities take advantage of higher yields without compromising safety or liquidity.
For funds not needed in the near term, selectively extending maturities may provide greater income stability and reduced reinvestment risk. This approach can provide more predictable investment income across budget cycles while preserving regular access to principal as investment positions mature.
The borrower perspective presents a different set of considerations in the current interest-rate environment. While most economies can generally withstand a broad increase in prevailing interest rates, even a substantial one, the pace of that increase is often more consequential than the magnitude alone. As noted in the table below, benchmark Treasury maturities are up 60–110+ basis points over the prior one-year period. However, a large proportion of this increase has materialized in the last 30 days.
The yield curve is also flattening. Short and intermediate maturities have increased more than longer-term maturities. In the last month, yields from 1–5 years are up 40–50 basis points, while the 30-year has declined nominally. This reflects the market’s current view that the FOMC will maintain a tightening bias, which is primarily expressed at the shorter end of the yield curve.
The tax-exempt municipal market doesn’t always march to the drum of U.S. Treasuries, as municipals represent a distinctly different and largely domestic universe of buyers. Municipals have not been as volatile as Treasuries but have generally followed a similar path at all maturities.
Since the beginning of September, broad measures of high-quality municipal bond yields are up 20–25 basis points across the maturity spectrum. This recent backdrop has also diminished demand. Lipper reported $1.8 billion of outflows from municipal bond funds the week of this publication, breaking a five-month-long streak of inflows. Outflows have been the most pronounced in high-yield funds with lower-quality credits. There have been weeks with new issue supply in the range of $12–$16 billion, which exceeds recent averages under $10 billion. The rapid rise in yields has had the greatest impact on lower-quality credits, resulting in materially higher credit spreads than at the start of the year.
While borrowing costs are certainly up, it’s worthwhile to examine results in some of Ehlers’ core markets. In the last two weeks our clients have priced both competitive and negotiated transactions. Competitive sales can often provide a strong barometer of dealer and investor sentiment during periods of volatility.
Strong credits have priced well on a historical basis. A recent sale of tax-exempt, bank-qualified G.O. Bonds by a AA+ rated Minnesota City with a 20-year term received 10 bids with a True Interest Cost (TIC) of 3.99%. A smaller AA issue with a 15-year term garnered seven bids and priced with a TIC of 3.98%. A Wisconsin AAA-rated issuer sold both tax-exempt and taxable issues concurrently. The tax-exempt issue was non-BQ, had a 20-year term, and received six bids with a winning TIC of 4.19%. The taxable series was shorter at 10 years, received four bids, and was awarded at a TIC of 5.09%.
These results remain constructive, but market volatility has made investors more selective. Lower-credit issuers are bearing more of the burden and should give additional attention to market access, debt structure, and method of sale. Headlines around “increased” rates are far more indicative of activity around the shorter end of the interest rate curve. Governmental entities are generally long-term borrowers where costs remain reasonable on a historical basis. Additionally, incorporating a reinvestment and arbitrage strategy into your borrowing plan can be highly effective at lowering net interest cost.
Setting proper expectations with your Municipal Advisor is important at moments like these. Attempting to time the market is generally a futile effort. All options should be evaluated based on the nature of the financing and the needs of the issuer.
Several factors are likely to shape the interest-rate outlook through the remainder of 2026, including geopolitical developments that affect global supply chains and commodity prices, the market’s perception of FOMC decisions regarding overnight rates, and whether the resilience of the labor market and consumer continues over the near and medium terms.
The appropriate debt and investment strategy varies by entity and your specific needs. If you are interested in discussing your current debt or investment needs, reviewing cash-flow assumptions, or exploring alternative investment strategies, please contact your Ehlers Municipal Advisor or Investment Adviser to schedule some time to discuss.
Required Disclosures: Please Read
Ehlers is the joint marketing name of the following affiliated businesses (collectively, the “Affiliates”): Ehlers & Associates, Inc. (“EA”), a municipal advisor registered with the Municipal Securities Rulemaking Board (“MSRB”) and the Securities and Exchange Commission (“SEC”); Ehlers Investment Partners, LLC (“EIP”), an investment adviser registered with the SEC; and Bond Trust Services Corporation (“BTS”), holder of a limited banking charter issued by the State of Minnesota.
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