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.

Over the past week, the fixed income markets continue to react to the uncertainty created by on-again/off-again tariff announcements and the de-escalation of tensions between the President and the Fed.  Treasury bonds have outperformed municipals, particularly on the long end of the yield curve, were yields on Treasury bonds have dropped 20 bps versus a 5 bps decline on municipals.  The strong moves in Treasury bonds are driven by a resurgence in risk appetite while municipals are responding to improved muni/Treasury ratios.  However, last week the term premium, which is the additional yield required on longer maturities, hit 80 bps which is the highest level we have seen in over a decade.  Although we are seeing more confidence in the long-end of the yield curve, investors remain cautious amid the uncertainty.

This morning, investor sentiment remains resilient with secondary trades executing at relatively tight levels.  Volatility has been uncharacteristically high following Liberation Day resulting in pricing discovery as investors test MMD spreads and question evaluated prices.  Current market dynamics remain challenging to manage from a trading perspective due to the combination of economic uncertainty, fund flows and the strength of recent moves.  

Municipal yields and Treasury yields continue to move in opposite directions.  Over the past week, Treasury bonds sold-off on the long-end of the curve as investors price-in macroeconomic concerns of mounting inflationary pressures from tariffs and economic uncertainty.  In contrast, municipal bonds rallied on the long-end as investors took advantage of more appealing ratios and sentiment the sell-off the previous week was overdone.  Treasury bonds on the shorter end of the curve in the two to four-year tenor, which tend to be more policy sensitive, fell by nine basis points as the market continues to struggle with on-again/off-again tariffs.

Last week marked the ninth straight week we have seen the additional yield investors demand to own 30-year Treasuries versus two-year maturities increase.  This gap reached levels last seen in 2022 and is only one of two periods of this magnitude that Bloomberg has recorded since it began collecting this data in 1992.   The U.S. economy is facing considerable turbulence (including geopolitics), with the potential positives of tax reform and deregulation and the potential negatives of tariffs and trade wars, ongoing sticky inflation, high fiscal deficits and high daily volatility.

The municipal bond market has experienced uncharacteristically high volatility over the past week amid escalating tariff threats and retaliatory measures from U.S. trade partners.  Daily changes in the municipal market swung wildly in both directions with almost 50 basis points of bumps on Thursday following 42 basis points of cuts on Wednesday.  This is extreme for a market accustomed to days where yields finish the day unchanged.  Today we are continuing to see cautious attitudes with accounts hanging-out in the safety of cash versus wading back into the market.

Volatility remains uncharacteristically high following last week’s tariff announcement and escalating pressure from the markets and politicians to cut rates.  However, last Friday, the Fed clearly stated their concerns regarding the potential for higher inflation and slower growth and has concluded it is too soon to determine the appropriate path for monetary policy.  As a result, market attentions are divided between concerns of stagflation and the prospects of the fed cutting rates leading to increased volatility as the market flips back and forth.  This past week has been challenging to manage from a trading perspective as the MMD municipal market index has seen strong moves in both directions with bumps of 18 to 24 bps along the yield curve last Thursday and Friday and cuts of 18 to 20 bps indicated for today.