This morning, Treasury bonds sold-off amid surging oil prices as inflation fears drove yields higher.  As conflict in the Middle East escalates, disruption in tanker activity and supply concerns will remain in-focus.  Typically global conflict will place downward pressure on rates as investors seek safety; however, in a market already sensitive to inflation and the potential for further rate cuts oil driven inflation concerns have unsettled investors.  

Trading in munis has been muted today, with investors cautiously waiting for additional information.  Over the past month munis have generally lagged the rally in Treasuries, particularly for tenors past 2-years.  The result has been a Treasury curve that has flattened about 18 bps while the muni curve steepened by about 6 bps.  Recent activity is the continuation of a long-term trend in muni/Treasury ratios with ratios at the extreme short-end becoming more rich (less appealing) and ratios on the long-end becoming cheaper (more appealing).  Currently, ratios for maturities shorter than 1-year are yielding 58.5% of their Treasury equivalents while 30-year munis are yielding over 90% of equivalent Treasuries.  

Despite the headlines and anxiety leading up to last week’s supreme court ruling, which determined the reciprocal tariffs are illegal, the bond market’s response was fairly measured.  The Treasury market initially reacted with longer dated yields jumping approximately 6 basis points to 4.75%, before settling back as more information emerged.  The muted response was partly due to the markets anticipating the ruling by pricing-in the outcome in advance and partly due to the potential for replacement tariffs.  However, there remains significant uncertainty about when, or if, the billions in collected tariffs will be refunded.  Should the tariffs be refunded, the bond market currently anticipates the burden will be shifted to Treasury issuance and result in higher yields.

Last week we experienced the second government shutdown in just four months.  Following the approval of a spending package by Congress last Tuesday afternoon, funding for the majority of federal agencies was secured through September.  However, the package only funded Homeland Security through 2/13 (this Friday).  Keep in mind that Homeland Security isn’t just ICE, it also includes: TSA, FEMA, the Coast Guard and the Secret Service.  Should Homeland Security fail to receive funding, there is the potential for economic consequences and travel interruptions.

As a result of the shutdown, the Department of Labor was not able to issue its report on U.S. hiring in January, as scheduled last Friday.  The Bureau of Labor Statistics has rescheduled the release of The Employment Situation for this Wednesday, February 11 and CPI is scheduled to be released on Friday.  Unfortunately, the disruption in jobs data comes amid uncertainty regarding the strength of the labor market amid speculation about the timing of future interest rate cuts by the Fed.  Currently, the fed-funds futures market is anticipating a 25bps cut later this year in June.

Although the Federal Reserve’s rate decision was the primary economic event last week, the President’s announcement of his Fed chair nominee was arguably more impactful.  Markets had a mixed response to the selection of Kevin Warsh as the next Fed chair.  While his qualifications, particularly his experience as Fed governor from 2006 to 2011, were welcome news; there remains significant uncertainty about how he will balance the attentions of the Federal Reserve.  Fed policymakers have recently been divided on whether to prioritize labor market concerns or stubbornly high inflation that remains above target levels.

In addition, the partial shutdown of the government took effect on Saturday, as lawmakers struggle to find common ground on the funding of immigration agencies.  However, since Congress already passed half of this year’s funding bills last year, several federal agencies and programs continue to operate through September.  Nevertheless, the government shutdown still affects the departments of Defense, Homeland Security, Labor, Health and Human Services, Education, Treasury and Housing and Urban Development, in addition to agencies like the Securities and Exchange Commission.  Also, should the shutdown persists through the week, Friday’s Labor Department’s jobs report could potentially be delayed.  

This morning on the trade desk, accounts are distracted by Winter Storm Fern, which has created havoc from Texas to Maine with 24 states declaring emergencies.  In addition to widespread power outages, many roads and highways remain impassable and flight cancellations have reached levels not seen since the early days of the Pandemic.  Despite the inclement weather, Treasuries rose over the five to 30-year tenors resulting in yields dropping to their lowest levels since last week’s volatility.  Following a preliminary announcement by the Commerce Department of stronger than anticipated durable goods orders for November, gains were briefly pared.

Early last week, international events came into focus following instability in the Japanese bond market. Yields surged in the Japanese bond market following a pitch by Japanese Prime Minister Sanae Takaichi to cut taxes on food, which markets interpreted to mean increased government bond issuance.  The result was 40-year Japanese yields jumping to the highest level of any maturity of the nation’s sovereign debt in more than three decades.  In addition, escalating tensions over the control of Greenland with the threat of tariffs on European goods added to the melee.  The municipal bond market responded to the uncertainty with bonds selling-off.  As of the end of the day on Tuesday, MMD ultimately cut yields from 2bps in 2027-28 to 7 bps in 2041-56.

Last week, the Bureau of Labor Statistics reported a drop in the unemployment rate to 4.4% in December, down from 4.5% in November.  However, nonfarm payroll employment levels crept up by 50,000 workers, which was less than the downwardly revised 56,000 in November and short of analyst estimates.  Overall, it was a mixed report that supports the narrative of a low hire, low fire job market and is unlikely to inspire a rate cut at the FOMC meeting later this month.  Although December’s employment data did little to provide the clarity the capital markets are seeking, it was also not sufficiently weak to warrant a rate cut.  Currently, fed funds futures are pricing-in only a 5% change of the Fed cutting rates in January.

The markets responded to this news with Treasuries selling-off, largely around the policy sensitive 2-year tenor with Treasury yields largely unchanged past about 10-years.  Conversely, ‘AAA’ municipal yields fell across the curve, with the largest declines concentrated in the first few years.  The rally in munis was largely supply driven following a modest calendar at year-end and a bit of a slow start to the new year.  However, weekend news of the US central bank being subpoenaed by the Justice Department with threats of criminal indictment have markets concerned about Fed independence.  In addition, this week is a heavy week for economic data with December’s Consumer Price Index scheduled to be released on Tuesday and November’s Producer Price Index scheduled to be released on Wednesday.  As markets digest these events there is heightened level of risk for rate volatility over the next few days.  In addition, as shown below, ACM 10-year Treasury term premium are at about the highest levels seen in over a decade.  This is an indication of some nervousness about future and provides bond investors with a reward for assuming duration.

Although last week was a noteworthy week in terms of economic releases, yields  for maturities past 6-months are largely unchanged.  Last week’s economic releases included nonfarm payroll employment and the unemployment rate on Tuesday and the Consumer price Index on Thursday, hitting on both of the Fed’s primary goals of maximum employment and stable prices.  Both the unemployment rate, at 4.6%, and the number of unemployed, at 7.8 million, were little changed from September.  However, the current unemployment reading has crept up to the highest level seen in over 4-years.  In addition, the all items CPI index, released on Thursday, surprised with a decrease in year-over-year inflation to 2.7%.  The drop in inflation was largely attributed to a decline in the rent index and the owners’ equivalent rent index.  It is important to note that we will have another payroll release prior to the Fed’s January meeting.

Last week, the Fed held its final meeting of 2025, with officials voting to cut its policy interest rate by a quarter-point for a third consecutive meeting.  A lack of economic data, stemming from the longest-ever government closure, combined with a weakening labor market and lingering inflation has led to policy uncertainty.  As a result, the Fed’s decision was not unanimous, with two regional Fed bank presidents voting to hold rates steady with one Fed governor voting for a half-point cut and nine members voting for a quarter-point cut.  The market’s response to the decision has been relatively muted, with Treasuries rallying six to nine-basis points on the short-end of the curve and selling-off around four basis points on the long-end while munis were largely unchanged out to around 10-years and selling-off around two basis points on the long-end.

This past week, the Treasury curve shifted up eight to nine basis points in a parallel fashion from two years out while municipal yields remain essentially unchanged with the long end only about a basis point higher.  The result is a steeper Treasury curve with municipal bonds generally outperforming Treasuries.  Perhaps the most meaningful developments occurred in Treasuries on the extreme short-end with one-month and two-month yields rallying 10 to 20 basis points in anticipation of a Fed rate cut this week.  However, following last Friday’s release of the delayed core personal consumption expenditures price index form the Bureau of Economic Analysis, inflation concerns were reinforced with prices up 0.2% from August and 2.8% from the prior year.  As a result, the rate cut expected at the Fed’s final 2025 meeting later this week could potentially accelerate inflation concerns on the long-end.