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.  

This morning on the trade desk, accounts are distracted by Winter Storm Fern, which has created havoc from Texas to Maine with 24 states declaring emergencies.  In addition to widespread power outages, many roads and highways remain impassable and flight cancellations have reached levels not seen since the early days of the Pandemic.  Despite the inclement weather, Treasuries rose over the five to 30-year tenors resulting in yields dropping to their lowest levels since last week’s volatility.  Following a preliminary announcement by the Commerce Department of stronger than anticipated durable goods orders for November, gains were briefly pared.

Early last week, international events came into focus following instability in the Japanese bond market. Yields surged in the Japanese bond market following a pitch by Japanese Prime Minister Sanae Takaichi to cut taxes on food, which markets interpreted to mean increased government bond issuance.  The result was 40-year Japanese yields jumping to the highest level of any maturity of the nation’s sovereign debt in more than three decades.  In addition, escalating tensions over the control of Greenland with the threat of tariffs on European goods added to the melee.  The municipal bond market responded to the uncertainty with bonds selling-off.  As of the end of the day on Tuesday, MMD ultimately cut yields from 2bps in 2027-28 to 7 bps in 2041-56.

Last week, the Bureau of Labor Statistics reported a drop in the unemployment rate to 4.4% in December, down from 4.5% in November.  However, nonfarm payroll employment levels crept up by 50,000 workers, which was less than the downwardly revised 56,000 in November and short of analyst estimates.  Overall, it was a mixed report that supports the narrative of a low hire, low fire job market and is unlikely to inspire a rate cut at the FOMC meeting later this month.  Although December’s employment data did little to provide the clarity the capital markets are seeking, it was also not sufficiently weak to warrant a rate cut.  Currently, fed funds futures are pricing-in only a 5% change of the Fed cutting rates in January.

The markets responded to this news with Treasuries selling-off, largely around the policy sensitive 2-year tenor with Treasury yields largely unchanged past about 10-years.  Conversely, ‘AAA’ municipal yields fell across the curve, with the largest declines concentrated in the first few years.  The rally in munis was largely supply driven following a modest calendar at year-end and a bit of a slow start to the new year.  However, weekend news of the US central bank being subpoenaed by the Justice Department with threats of criminal indictment have markets concerned about Fed independence.  In addition, this week is a heavy week for economic data with December’s Consumer Price Index scheduled to be released on Tuesday and November’s Producer Price Index scheduled to be released on Wednesday.  As markets digest these events there is heightened level of risk for rate volatility over the next few days.  In addition, as shown below, ACM 10-year Treasury term premium are at about the highest levels seen in over a decade.  This is an indication of some nervousness about future and provides bond investors with a reward for assuming duration.

Although last week was a noteworthy week in terms of economic releases, yields  for maturities past 6-months are largely unchanged.  Last week’s economic releases included nonfarm payroll employment and the unemployment rate on Tuesday and the Consumer price Index on Thursday, hitting on both of the Fed’s primary goals of maximum employment and stable prices.  Both the unemployment rate, at 4.6%, and the number of unemployed, at 7.8 million, were little changed from September.  However, the current unemployment reading has crept up to the highest level seen in over 4-years.  In addition, the all items CPI index, released on Thursday, surprised with a decrease in year-over-year inflation to 2.7%.  The drop in inflation was largely attributed to a decline in the rent index and the owners’ equivalent rent index.  It is important to note that we will have another payroll release prior to the Fed’s January meeting.

Last week, the Fed held its final meeting of 2025, with officials voting to cut its policy interest rate by a quarter-point for a third consecutive meeting.  A lack of economic data, stemming from the longest-ever government closure, combined with a weakening labor market and lingering inflation has led to policy uncertainty.  As a result, the Fed’s decision was not unanimous, with two regional Fed bank presidents voting to hold rates steady with one Fed governor voting for a half-point cut and nine members voting for a quarter-point cut.  The market’s response to the decision has been relatively muted, with Treasuries rallying six to nine-basis points on the short-end of the curve and selling-off around four basis points on the long-end while munis were largely unchanged out to around 10-years and selling-off around two basis points on the long-end.

This past week, the Treasury curve shifted up eight to nine basis points in a parallel fashion from two years out while municipal yields remain essentially unchanged with the long end only about a basis point higher.  The result is a steeper Treasury curve with municipal bonds generally outperforming Treasuries.  Perhaps the most meaningful developments occurred in Treasuries on the extreme short-end with one-month and two-month yields rallying 10 to 20 basis points in anticipation of a Fed rate cut this week.  However, following last Friday’s release of the delayed core personal consumption expenditures price index form the Bureau of Economic Analysis, inflation concerns were reinforced with prices up 0.2% from August and 2.8% from the prior year.  As a result, the rate cut expected at the Fed’s final 2025 meeting later this week could potentially accelerate inflation concerns on the long-end.

Despite uncertainty regarding the reopening of the U.S. government, conflicting information from Fed policymakers and the wild swings in market sentiment regarding the prospects of another rate cut, yields on municipal bonds and Treasuries have changed relatively little over the past month.  Municipal yields for all tenors were generally within a basis point or less of their yields from the beginning of November and Treasuries were also relatively unchanged with a slight steepening as rates rallied modestly from 6-weeks to 5-years and sold off 7 to 10-basis points in tenors past 15-years.  The stability in the fixed income markets can partially be attributed to the lack of key economic data during the shutdown and the continuation of long-term trends with structural labor market concerns and continued stubbornly high inflation.

Economic data releases resumed last Thursday with the U.S. Department of Labor’s (BLS) release of the long-delayed September employment report.  The BLS report did not deliver the clarity that markets are seeking regarding the central bank’s likely path.  Although nonfarm payroll employment came in stronger than expected with 119,000 jobs added in September, the report also showed the jobless rate edging-up to the highest level in nearly four years to 4.4%.  The increase in the jobless rate is not all that surprising, given the widely reported agency-by-agency filings showing the administration attempted to terminate a total of 3,605 employees during the shutdown.  Employment gains were driven by health care, food services and drinking places, and social assistance.  To add to the market’s uncertainty, the BLS will not be publishing the October employment report until after the Fed issues its decision on December 10 which is also when it will be releasing November data. 

Following a record 43-day shutdown, the President signed legislation to reopen the government last Wednesday.  Although the government has reopened, there is a sizable backlog of government economic data that was not available during the shutdown. The bond market is currently bracing for a flood of data as traders anxiously pare December rate cut expectations.  As of this morning, the Fed funds futures market was only pricing-in a 41% chance of a 25 basis-point cut in December.  Current rate expectations have declined significantly from last week, when the implied probability was in the 60’s.  The tone has turned decidedly more hawkish as several FOMC members have recently cited heightened inflation concerns, which prompted a sell-off in Treasuries last Thursday.

Not surprisingly, this irresolute sentiment has resulted in Treasury yields that remain little changed from when the shut-down began on October 1.  However, the municipal market has demonstrated more conviction with steady demand and appealing relative yields weighing on the long-end while shifting dynamics on the short-end have led to municipals selling-off.  As a result, we have seen the municipal yield curve flatten, resulting in declining slopes and less incentive to extend duration.

Today marks the 41st day of the longest government shutdown in US history, and it appears a resolution is potentially close at hand.  On Sunday, eight Senate Democrats joined Republicans in a push to advance a short-term funding measure that would extend government funding through January.  However, the legislation still requires a final vote by the Senate and needs to pass the House before the shutdown can end.  Following this news, the Treasury market has slid with 10-year Treasuries rising as much as 5 basis points to near 4.15% amid optimism .  Some caution is also warranted since the re-opening may potentially trigger volatility as a surge of delayed data releases.  This absence of government data has made policymakers more cautious about cutting rates, which will likely fade as data is released upon re-opening.  The Fed funds futures market is currently pricing-in a 65% chance of a 25 basis-point cut in December.  This is down significantly from just a few weeks ago when the implied probability was closer to 95%.

Today marks the 34th day of the US government shutdown, and despite the lack of government economic data and the continuous flow of headlines, there has been little response by the Treasury market.  Yields on Treasuries are little changed over the past month with the biggest changes on tenors under 6 months and the rest of the curve virtually unchanged.  Munis in tenors past 6-years have rallied as much as 20-basis points over the past month with the Bloomberg Municipal Index reporting a 1.24% return, which is the best October performance since 1995.  This performance was despite $55 billion of tax-exempt issuance.  Municipal tenors shorter than 6-years sold-off as demand shifted from the front end of the yield curve to the long-end as investors locked-in yields in anticipation of Fed rate cuts.  

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.