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.

Despite uncertainty regarding the reopening of the U.S. government, conflicting information from Fed policymakers and the wild swings in market sentiment regarding the prospects of another rate cut, yields on municipal bonds and Treasuries have changed relatively little over the past month.  Municipal yields for all tenors were generally within a basis point or less of their yields from the beginning of November and Treasuries were also relatively unchanged with a slight steepening as rates rallied modestly from 6-weeks to 5-years and sold off 7 to 10-basis points in tenors past 15-years.  The stability in the fixed income markets can partially be attributed to the lack of key economic data during the shutdown and the continuation of long-term trends with structural labor market concerns and continued stubbornly high inflation.

Economic data releases resumed last Thursday with the U.S. Department of Labor’s (BLS) release of the long-delayed September employment report.  The BLS report did not deliver the clarity that markets are seeking regarding the central bank’s likely path.  Although nonfarm payroll employment came in stronger than expected with 119,000 jobs added in September, the report also showed the jobless rate edging-up to the highest level in nearly four years to 4.4%.  The increase in the jobless rate is not all that surprising, given the widely reported agency-by-agency filings showing the administration attempted to terminate a total of 3,605 employees during the shutdown.  Employment gains were driven by health care, food services and drinking places, and social assistance.  To add to the market’s uncertainty, the BLS will not be publishing the October employment report until after the Fed issues its decision on December 10 which is also when it will be releasing November data. 

Following a record 43-day shutdown, the President signed legislation to reopen the government last Wednesday.  Although the government has reopened, there is a sizable backlog of government economic data that was not available during the shutdown. The bond market is currently bracing for a flood of data as traders anxiously pare December rate cut expectations.  As of this morning, the Fed funds futures market was only pricing-in a 41% chance of a 25 basis-point cut in December.  Current rate expectations have declined significantly from last week, when the implied probability was in the 60’s.  The tone has turned decidedly more hawkish as several FOMC members have recently cited heightened inflation concerns, which prompted a sell-off in Treasuries last Thursday.

Not surprisingly, this irresolute sentiment has resulted in Treasury yields that remain little changed from when the shut-down began on October 1.  However, the municipal market has demonstrated more conviction with steady demand and appealing relative yields weighing on the long-end while shifting dynamics on the short-end have led to municipals selling-off.  As a result, we have seen the municipal yield curve flatten, resulting in declining slopes and less incentive to extend duration.

Today marks the 41st day of the longest government shutdown in US history, and it appears a resolution is potentially close at hand.  On Sunday, eight Senate Democrats joined Republicans in a push to advance a short-term funding measure that would extend government funding through January.  However, the legislation still requires a final vote by the Senate and needs to pass the House before the shutdown can end.  Following this news, the Treasury market has slid with 10-year Treasuries rising as much as 5 basis points to near 4.15% amid optimism .  Some caution is also warranted since the re-opening may potentially trigger volatility as a surge of delayed data releases.  This absence of government data has made policymakers more cautious about cutting rates, which will likely fade as data is released upon re-opening.  The Fed funds futures market is currently pricing-in a 65% chance of a 25 basis-point cut in December.  This is down significantly from just a few weeks ago when the implied probability was closer to 95%.