Quarterly Analysis of Fidelity Tax-Free Bond Fund, as of Q2 2025
Investment-grade tax-exempt municipal bonds, a popular choice for income-seeking investors, experienced a challenging second quarter (Q2) of 2025. However, they managed to rebound late in the quarter, demonstrating resilience amid a turbulent macro environment.
The quarter began with a slightly negative return of about -0.12% for the Bloomberg Municipal Bond Index, reflecting pressures from heavy new issuance, tax-season selling, and market volatility early in the quarter. However, May and June produced partial recovery with positive returns totaling approximately 0.69%, nearly offsetting April’s 0.81% loss, leading to modest stability by quarter-end.
Key factors contributing to their Q2 performance were high issuance volumes, strong investor demand, interest rate dynamics, the enduring appeal of tax-exempt income, and solid credit fundamentals. State and local governments issued $163.7 billion in Q2 2025, outpacing projections and adding significant supply to the market. Despite this, retail and institutional demand remained strong, with net inflows to municipal bond funds for most weeks of the quarter.
Treasury yields, especially the 10-year, rose sharply in April before declining in May and June due to easing inflation expectations, progress on tariffs, and geopolitical concerns. Muni yields spiked early then declined, impacting bond prices and total returns. The enduring appeal of tax-exempt income, along with solid credit fundamentals, supported investor interest and valuations.
In terms of performance, the Bloomberg Municipal Bond Index had a slightly negative Q2 (–0.12%), mitigated by gains in May and June. Municipal bonds outperformed on a yield advantage and favorable fundamentals for the year to date, despite the initial volatility and heavy supply.
The Fidelity® Tax-Free Bond Fund, a fund that focuses on fundamental credit analysis, yield-curve positioning, and analysis of the structural characteristics of each security, also experienced a mixed performance. The fund's portfolio is diversified across sectors such as Transportation, Health Care, Local Obligations, State Obligations, Special Tax, Corporate-Backed, Electric & Gas, Higher Education, Housing, Water & Sewer, Tobacco, Pre-Refunded, Lease/Other, and Cash & Net Other Assets.
The fund's performance summary for the 3-month, YTD, 1-year, 3-year, 5-year, 10-year periods, and Lipper General & Insured Municipal Debt Funds Classification are provided. The fund emphasizes a total-return approach that seeks to generate a level of tax-exempt income consistent with the preservation of capital.
Munis trimmed their losses relative to taxable bonds following President Trump's announcement of a 90-day pause on most tariffs. From a sector perspective, revenue bonds were roughly in line with general obligation bonds, with state-backed bonds outperforming local government-backed debt.
However, the municipal market is volatile and can be significantly affected by adverse tax, legislative, or political changes and the financial condition of the issuers of municipal securities. The fund's characteristics include Duration (7.59 years), 30-Day SEC Yield (3.86%), 30-Day SEC Restated Yield (3.67%), 30-Day SEC Tax-Equivalent Yield (6.52%), Net Asset Value ($10.73), and Subject to Alternative Minimum Tax (0.00%).
In brief, investment-grade tax-exempt municipal bonds posted a modest negative return in Q2 2025 but rebounded late in the quarter, with strong issuance and demand, interest rate volatility, and tax exemption status driving their performance. The fund's performance mirrors these trends, with a diversified portfolio and a focus on total return.
- Amid the turbulent macro environment in Q2 2025, investment-grade tax-exempt municipal bonds demonstrated resilience through strong investor demand, particularly in the retail and institutional sectors.
- The high issuance volumes of hospitals, educational institutions, and state and local government projects contributed significantly to the supply of municipal bonds in Q2 2025.
- For income-seeking investors nearing retirement, the tax-exempt income from municipal bonds can serve as a crucial component of their long-term financial planning, providing stability and reducing tax liabilities.
- In efforts to address environmental concerns, government funds could be invested in municipal bonds issued by organizations focusing on renewable energy projects, water and sewer infrastructure, and environmental protection initiatives.
- As part of a well-diversified investment portfolio, considering the addition of real-estate investment trusts (REITs) or other assets can help mitigate the potential volatility sometimes associated with municipal bonds and optimize returns during various market conditions.
