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Do Rates Drive Muni Performance?

April 05, 2022

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The municipal bond market generally tends to move with the U.S. Treasury market, but not always. Despite rising rates, we believe munis will deliver positive performance by year-end.

While the municipal bond market generally follows rate changes in the U.S. Treasury market, it does not move in lock step, which is why sometimes we see muni-treasury ratios upwards of 80% to low 90%. This is because the typically low volatility of munis is directly related to the fact that only approximately 2% of all outstanding bonds trade in a given day, making it challenging to reprice all of the bonds that do not trade.

The chart below shows that even over a long history of Fed rate policy changes across a variety of market cycles, municipal bonds have consistently delivered positive returns. A contributing factor is that the tax exemption is valuable in all rate and tax environments to many types of investors. The chart depicts that looking back over the last 26 years, munis have delivered negative returns during only four of those years. Throughout those periods, both rates and credit concerns were working together to drive down all fixed income, unlike the current situation.

Yearly Muni Index Returns and Changes in Fed Funds Rate

Yearly Muni Index Returns and Changes in Fed Funds Rate

Source: Morningstar and FRED. As of 3/17/2022.Past performance is no guarantee of future results.

The prevailing coupon of most municipal issues is 5%, and since total return includes both price movements as well as income, greater price declines than we have seen recently would need to continue through the balance of the year, which we feel is unlikely. We believe it is likely that 2022 will also deliver modestly positive performance by year-end.

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This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities/financial instruments mentioned herein. The information herein represents the opinion of the author(s), but not necessarily, those of VanEck and these opinions may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only.

An investment in the Funds may be subject to risks which include, fund of funds risk, high portfolio turnover, model and data risks, management, operational, authorized participant concentration and absence of prior active market risks, trading issues, market, fund shares trading, premium/discount and liquidity of fund shares and non-diversified risks. The funds may be subject to following risks as a result of investing in Exchange Traded Products including municipal securities, credit, high yield securities, tax, interest rate, call, state concentration and sector concentration risks. Municipal bonds may be less liquid than taxable bonds. There is no guarantee that a Funds’ income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax (AMT) rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Capital gains, if any, are subject to capital gains tax. A portion of the dividends you receive may be subject to AMT. For a more complete description of these and other risks, please refer to each Fund’s prospectus.

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