So much for that sleepy reputation.

The municipal-bond market used to be a reliably boring one, full of small cities, state governments and others borrowing to build sewers, roads and hospitals. But in the last decade, the muni market has been all-too-interesting and whipped investors through several sell-offs.

The latest struck in November, when the largest muni-bond fund had its worst month since the 2008 financial crisis. It lost 3.4 percent on worries that the incoming White House and Congress would cut tax rates and pursue other moves that could weaken muni bonds’ appeal. Since then, though, muni funds have clawed back about half their losses and look to be on their way to erasing yet another downturn.

Looking ahead, muni fund managers say they expect the market to remain interesting. Volatility will likely remain as Washington continues to debate changes to the tax system. Returns, meanwhile, will likely be lower than in past years, but managers say they can still grind out modest gains.

“What the last two years have taught us is: Don’t panic,” said Hugh McGuirk, head of municipal bonds at T. Rowe Price.

Few were taking that advice in November, when prices for all types of bonds fell on expectations that faster economic growth and inflation may be on the way.

Munis fell even more on fears that some proposals would directly hit the market, chiefly a rewrite of the tax code. The income that municipal bonds pay can be exempted from income taxes. Tax reform could put the exemption in the cross hairs.

It’s becoming clear that change could be slower to occur in Washington than initially expected, if it happens at all.

Even if tax reform and an infrastructure program do pass, the effects may not be as bad for the market as many had feared. A drop in the top tax rate would likely hurt muni bond prices but doesn’t have to be a catastrophe. Munis held their own after President George W. Bush enacted tax cuts in 2001, for example.

Now, regular investors are coming back to the market. They have put more money into muni funds than they have taken out for three straight months, after fleeing in November and December.

So, how much is fair for them to expect in returns?

One benchmark index that many muni funds follow has already returned close to 1.7 percent in the first quarter of the year. Don’t except that every quarter.


Stan Choe writes for the Associated Press