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.