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.