Last week, the President signed into law his “Big Beautiful Bill,” which reportedly contains roughly $4.5 trillion in tax cuts, and protects the tax exemption for municipal bonds and private activity bonds.  The Bill also creates a new category of private activity bonds for “spaceports” and includes a few additional bond-related provisions.  The preservation of the tax-exemption is of critical importance to the municipal bond market.

Treasury and municipal market yields rallied over this past week as the market fixated on the potential for the Fed to cut rates earlier than previously forecast.  Sentiment was driven by dovish Fedspeak from Fed governors Bowman and Waller, first quarter GDP revisions to -0.5% and a benign May PCE report, all of which bolstered rate cut expectations.  The futures market is now anticipating the Fed could cut rates as soon as September.  However, Fed Chair Powell’s comments made last week to the House Financial Services Committee were clear, that the Fed is well positioned to wait citing elevated inflation and intensifying price pressures.  Powell also commented that signs of weakness in the labor market would change the Fed’s stance.  As a result, we may see some volatility in the capital markets following this week’s employment data releases on Tuesday and Thursday.

Although last week was a holiday week, there was a steady stream of potentially impactful headlines ranging from escalating tensions in the Middle East to an FOMC meeting.  Although Fed officials left interest rates unchanged at last week’s meeting, the conflict in the middle east has disrupted air traffic, rattled global markets, and raised concerns of oil prices and inflation.  However, Treasury bond yields generally slid last week amid elevated recession concerns following a disappointing release of data by the Census Bureau indicating retail sales dropped by 0.9% in May, significantly below the 0.6% contraction previously estimated by economists surveyed by Dow Jones.

From the perspective of the trade desk, last week was another challenging week with attentions focused on new deals rather than the secondary market.  Both municipal and Treasury markets responded to last week’s reports of slower growth and lower inflation with yields dropping approximately three to six basis points across both curves.  However, this week escalating overseas tensions in Israel and Iran are placing upward pressure on yields.  Not surprisingly, both Brent and West Texas Intermediate crude oil prices have risen above $70 per barrel sparking concerns of inflation among traders and placing additional upward pressure on long-term yields.  These concerns are in addition to the existing inflationary concerns related to the trade wars, spiraling U.S. debt concerns and traders demanding a higher premium for the risk of lending to governments following Moody’s downgrade of the United States credit rating to ‘Aa1.’  Overall, the yield gap between 10 and 30-year Treasuries has reached the widest levels we have seen since 2021.

Last week, the municipal market was flooded by issuance as state and local governments unloaded $20 billion in new deals, marking the largest issuance volume in almost eight years.  The municipal market is anticipating another big week with issuers currently scheduled to bring $17 billion in new deals to market ahead of the upcoming FOMC meeting and the Juneteenth holiday.  However, despite the challenging volume of deals being processed by the market, municipal yields have held steady, even outperforming Treasuries, with a rally of two to three basis points in tenors under ten years and a minor sell-off of one to one and a half basis points out long.  As a result, the MMD municipal yield curve has modestly steepened by about 11 basis points over the past week.  In contrast, Treasuries have flattened from two to 30-years with tenors under ten years selling-off as much as ten basis points as the Treasury market responded to a stronger than expected jobs report and continued policy uncertainties.

Long-term US Treasury yields have recently popped-up to their highest level in over a year, driven by the passage of the budget by the US House of Representatives and widespread concerns of escalating deficits.  The biggest deficit driver is the proposed extension of the Tax Cuts and Jobs Act of 2017, which is estimated to add $3.5 to $4.0 trillion to the current deficit, likely requiring the issuance of additional Treasury securities.  However, demand for Treasuries is waning as countries like China and Japan have been decreasing their holdings due to trade tensions and a stronger US dollar.  Yields on 2, 5 and 10-year notes, by comparison, have fallen resulting in a widening gap between the 10-year and the 30-year bond.  Although this gap is widening, it is still within long-term historical averages.