The shutdown, which is now the third longest government shutdown in U.S. history, continues to populate headlines.  In addition, markets are operating without the usual government sourced economic data from the Bureau of Labor Statistics and the Bureau of Economic Analysis.  Absent this data, the markets have been looking to private sources and anecdotal data from businesses for guidance.  However, data from these sources is less than optimal and is typically not as broad or representative of the economy as government data sets.  Due to the weakening job market and a lack of updated government data to demonstrate otherwise, the markets are operating under the assumption the Fed will make another quarter of a point cut at its meeting next week.  Last week, Fed chair Jerome Powell indicated that economic concerns of the Fed had not changed during the data blackout.  The Fed funds futures market is currently indicating an almost certain 94.6% chance of a 25bps rate cut at the Fed’s October 29 meeting and an additional 25bps cut in December.

Over the past week, Treasury and municipal markets have been largely unphased by the shutdown or the regional bank distress with yields experiencing minimal change on the long end of the yield curve.  Treasury yields rallied about 4.55 bps versus 5.5 bps for munis.  On the more policy sensitive short tenors under 2-years, yields differed with Treasuries selling-off a little over 5 bps and munis rallying around 3 bps.  Treasuries have lately been responding to haven buying, trade tensions and anxiety related to regional bank credit exposure.

Although the U.S. government shutdown last week, Treasury and municipal markets were largely undaunted with yields experiencing only minimal change.  However, the shutdown has resulted in the Bureau of Labor Statistics postponing its Employment Situation report, which is ordinarily delivered on the first Friday of the month, to report on employment levels and unemployment.  Despite the lack of data, Treasury yields only moved down by about 4 bps on the short-end and up by about 5 basis points on the long-end with the 5-year tenor essentially unchanged.  Muni yields moved in almost the opposite direction, with short yields climbing 2 basis points and long yields falling about 3.5 basis points and, like Treasuries, 5-year yields were essentially unchanged.  Furthermore, the Fed funds futures market is currently indicating an almost certain 94.6% chance of a 25bps rate cut at the Fed’s October 29 meeting.

With government funding set to expire Tuesday, the shadow of a potential government shutdown continues to loom over the bond market bringing yields down across the Treasury curve.  In addition, the shutdown threatens to delay the release of key economic data, including Friday’s nonfarm payroll employment data and unemployment rate from the Bureau of Labor Statistics.  This data is critical to current rate forecasts as weakening employment data was an influential factor in the Fed’s decision to cut rates earlier this month.  The Fed has recently commented that labor demand, and the recent pace of job creation, appear to be running below the “breakeven” rate needed to maintain current unemployment levels.  The Fed funds futures market is currently indicating an 88.7% chance of a 25bps rate cut at its October 29 meeting.

Attentions are focused on the Fed this week with their rate decision scheduled to be announced on Wednesday.  Traders are positioning ahead of Wednesday’s meeting with Fed funds futures continuing to demonstrate conviction of a 25 bps cut.  However, inflation has been creeping higher in recent months and is keeping the Fed cautious.  Last week, the Consumer Price Index for All Urban Consumers increased 0.4% on a seasonally adjusted basis for August after rising 0.2% in July.  The all-items index rose 2.9 percent for the 12-month period ending August, which is significantly above the Fed’s 2% inflation target.  However, many traders are arguing that weaker jobs data outweighs concerns of higher prices.  Last week the Bureau of Labor Statistics reported the U.S. labor market added 911,000 fewer jobs than previously reported, which many in the bond market are interpreting as additional justification for the Fed to cut rates later this week.

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.