Over the past week, both municipal bonds and Treasuries have experienced a meaningful rally which shifted rates lower as sentiment intensifies in anticipation of a Fed rate cut.  Momentum picked-up as the week progressed, with 10-year Treasury yields charging through key support levels on Thursday and Friday.  Ultimately, the largest moves happened on Friday following the release of nonfarm payrolls by the Bureau of Labor Statistics which contributed to bumps in the municipal yield curve ranging from 2 bps in 2026 to 12 bps in 2055.  Prior to the data release, economists surveyed by Dow Jones were anticipating payrolls would rise by 75,000 jobs in August versus the actual survey report of only 22,000 jobs.  In addition to a disappointment versus the survey, this is a significant slowdown from July’s 79,000 job increase.  While the labor market is showing meaningful signs of cooling, unemployment remains at a historically healthy 4.3% and total non-farm payroll continues to set new monthly records.  This morning, the Fed funds futures market is pricing-in a 112% chance of a 25 bps cut at next week’s meeting.

Jerome Powell delivered his highly anticipated keynote address at the Jackson Hole Economic Policy Symposium last Friday.  Prior to the meeting, the bond market’s forecast of a 25 basis point cut at the Fed’s September 16-17 meeting had been diminishing, with Fed Funds Futures indicating the likelihood in the mid-70’s.  Although Powell’s comments were largely cautious, the markets have interpreted his comments as a dovish shift with the probability of a rate cut now pricing in the low 80’s.  Important takeaways from the speech include the conflicting position the Fed faces, amid mounting political pressures, with inflation pegged stubbornly above its 2% target and a languishing labor market.  Perhaps more importantly, and generally ignored by the media, Powell outlined a new framework to guide future Fed decisions.  The Fed’s revised framework is designed to evolve with changes in the structure of the economy and how the Fed interprets those changes.  To accomplish this objective, the language in the existing framework was revised to shift focus away from the effective lower bound and remove some of the communications challenges the Fed has faced in the past with regard to the labor market.

Inflation comes into a closer focus today in the Treasury market with Fed Funds Futures now reflecting an 84% chance of the Fed cutting rates next month.  This is down significantly from last week when the probability was over 100%.  Last week, the credit markets continued to focus on the August 1st Bureau of Labor Statistics nonfarm payrolls report, which included a cumulative downward adjustment of 258,000 jobs and convinced capital markets that a September rate cut was certain.  However, the release of last week’s Producer Price Index, which jumped 0.9% on the month, compared with the Dow Jones estimate for a 0.2% gain, has markets casting doubt.  Although the jobs data was striking, last week’s PPI is the biggest monthly increase we have seen since June 2022 and has the markets re-calibrating expectations.

The municipal yield curve steepened over the past week with a rally in the muni market driving yields down across the curve amid aggressive bidding on the short-end in anticipation of a September Fed rate cut.  Inquiries on the trade desk continue to be concentrated within 10-years and maturities under 5-years are pricing at notably tight levels.  Treasuries, in contrast, flattened over the past week with the market selling-off from 6-months to 30-years with yields rising with greater consequence on the short-end than the long-end.  The August 1st Bureau of Labor Statistics nonfarm payrolls report continues to weigh on the markets with traders focusing on softer payrolls data as justification for the Fed to cut rates at its next meeting.  In addition, the nomination of Council of Economic Advisers Chairman Stephen Miran to serve out the final few months of Adriana Kugler’s seat following her surprise resignation last week has been viewed by the markets as a potentially dovish development.

With the August 1 tariff deadline, a full economic calendar and an FOMC meeting, last week was bound to be a dynamic week.  However, it was Friday’s nonfarm payroll report that proved most impactful.  Total nonfarm payrolls disappointed with little change reported in July with an additional 73,000 jobs, well below Dow Jones’ expectation of 100,000.  Furthermore, the unemployment rate ticked up to 4.2% alongside another decrease in the labor force participation rate.  However, the revisions to May and June were more impactful, with totals revised sharply lower, by a combined 258,000 jobs from previously announced levels.  Markets subsequently repriced the policy outlook for the Fed’s next rate cut with the futures market pricing in the probability of a September rate hike over 90%.  The news was promptly absorbed by the municipal yield curve without prejudice of maturity, with a 7 bps bump per year from 2026 to 2055, resulting in a parallel drop lower in yields.  The Treasury market also responded with yields dropping, largely in the policy sensitive 2-year note, which fell as much as 28 bps.

Throughout the month of July, both the Treasury and municipal yield curves experienced meaningful steepening.  Munis steepened more than Treasuries, largely due to yields falling on the short-end of the curve rather than yields climbing on the long-end.  For the Treasury curve, the steepening was less pronounced as 30-year yields climbed only 2.5 bps and yields around the 1-year mark dropped a significant 16bps.  Currently, the municipal curve is at its steepest around the 10-year tenor with 51 bps of slope from 8 to 11-years.  In addition, after this past week, the curve has steepened notably around the 5-year tenor with 33 basis points of slope from 4 to 7-years.  Overall, the steepness of both curves provides significant incentive for duration extension.