In the period following the announced tariffs on April 2nd, Municipal bonds have fared better than Treasury bonds, with 30-year Treasury bonds selling-off by 44 basis points while similar municipals sold-off by only 32 basis points.  However, it is in the 15-year portion of the Treasury curve where investors are most unsettled as the Treasury bond market backed-up 54 basis points versus only 23 basis points in municipals.  The result is flattening on the longer end of the Treasury curve with a slope of only 7 basis points from 15 to 30-years.  Treasury bonds are responding to the long-term inflation outlook, national debt concerns and consumer anticipation of steeper price pressures with uncertainty leading to flattening on the long-end.  The municipal curve has evolved to become more consistently sloped with longer duration municipals responding more to technical factors such as new issuance and fund flows.

This morning municipal bonds are selling-off following Friday’s downgrade of the US Treasury by Moody’s from ‘AAA’ to ‘Aa1.’  In early trading yields extended over 5% for 20 and 30-year Treasury bonds, although yields have since settled back under 5% for both tenors.  Moody’s downgrade was prompted by their concern of a decade of increasing debt and interest payments to levels significantly higher than similarly rated sovereigns and by successive US administrations that failed to agree with Congress on measures to reverse the trend.  In addition, Moody’s commented the ratio of total US public debt to the size of the economy has reached 98% of GDP in 2024 and anticipates the federal debt burden will reach 134% of GDP by 2035.  Moody’s also changed its outlook on the US economy from negative to stable and commented that it expects US GDP growth to slow in the short-term as the economy adjusts to higher tariffs, but that it does not expect long-term growth to be significantly affected.

This morning’s announcement of a reprieve in the trade war between the US and China sparked a seven-basis point increase in the 10-year Treasury yield as traders pushed back the timing of possible interest-rate cuts.  The trade war has been the biggest driver of rates in the capital markets this year, marking a significant shift from the previous focus on the Fed.  Last week, the Fed held rates steady at 4.25% to 4.5% and cited the trade talks as a key factor amid concerns of increased unemployment and higher inflation.  Volatility from the trade war has been elevated in the Treasury bond market with trading surging 25% in April to a record $1.323 trillion in average daily turnover, which almost doubled to $2.44 billion on the peak day with trade war volatility driving position unwinds.

Not surprisingly, uncertainty in the municipal bond market also remains uncharacteristically high.  Last week, LSEG Lipper Global Fund Flows reported that investors added $1.1 billion to municipal bond funds.  As a result, technical conditions improved in the muni market last week as robust supply was met with solid demand.  Long-term muni funds gained $597 million while intermediate funds saw inflows of $96 million and high-yield funds added $348 million.  Overall, the fund flows point to risk-on as investors migrate to the long-end of the curve and riskier assets.  From the perspective of the Charlotte trade desk, trades this morning have been a little soft but ratios have recently compressed and inventory struggles to keep pace with demand.

Over the past week, yields in the municipal and Treasury markets have moved in opposite directions as uncertainty and volatility continue to be prominent themes in the fixed income markets. Based upon guidance from the Fed, traders are betting policymakers will remain in wait-and-see mode until there’s more clarity on tariffs. As a result, the longer policy uncertainty persists, the greater the potential economic impact. Although, the futures market is pricing in over a 98% chance the Federal Reserve will leave rates unchanged at their meeting later this week, the market is anticipating a 25 bps cut as soon as the July 30 meeting. In addition, the market is anticipating three rate cuts this year which seems questionable given job gains reported by the BLS last week and the Fed’s previous comments regarding timing. Nevertheless, the primary concern is not whether or not the fed cuts rates, but rather the specific language used by the Fed in its message and the potential volatility should the Fed indicate increased likelihood of a recession. Although we are seeing more confidence in the long-end of the yield curve, particularly in municipals, investors remain cautious amid the uncertainty.