Inflation is showing signs of heating-up as the first inflation report under new Federal Reserve chief Kevin Warsh was released last week showing April consumer prices reached their highest level in almost three years.  The personal consumption expenditures price index ticked-up to 3.8% for the 12-month period ended in April, almost double the Fed’s 2% target.  However, this was not unexpected, as economists surveyed by Dow Jones forecasted a 3.8% rate.  In the Treasury Market, inflation expectations have increased anticipation the Fed will hike rates, resulting in the gap between five-year and 30-year yields narrowing to the skinniest levels seen in more than a year.  As a result, we have seen short and intermediate Treasuries underperform over the past month.  However, fund flows in the muni market remain robust, with investors adding approximately $2.3 billion last week, according to LSEG Lipper Global Fund Flows.  As a result, munis have held their ground better than Treasuries over the past month.

Last week, there was a global selloff in government bonds as markets recalibrated inflation risk amid surging energy prices and speculation that central banks will tighten monetary policy.  The Bureau of Labor Statistics (BLS) released its CPI report last Tuesday, which indicated that prices rose 0.6% from March and 3.8% from a year earlier.  This is the highest annual reading since May 2023 and significantly above the 0.3% and 2.7% that economists had forecast.  To compound matters, on Wednesday, the BLS released its Producer Price Index which showed prices climbing 6% year-over-year in April.  The resulting selloff was propelled by climbing crude oil prices and a US-Chinese summit that delivered only modest results and no breakthroughs on the war in Iran.  Not surprisingly, the sentiment in the Fed funds futures market has fluctuated dramatically over the past month from the Fed cutting rates to the Fed now hiking rates as soon as next March.

The Bureau of Labor Statistics released its Employment Situation report last Friday which reported nonfarm payroll increased by 115,000 jobs in April, despite rising energy costs from the Iran war.  This is significant as the markets contemplate the future rate path of the Fed and its dual mandate to promote both maximum employment and stable prices.  Collectively, the job gains in March and April mark the strongest two-month increase since 2024.  Recent employment data gives the Fed justification to maintain interest rates at current levels, for the foreseeable future, while they focus on inflationary risks from rising energy prices.

Last week the Fed voted to leave its policy rate unchanged at 3-1/2 to 3-3/4 percent citing developments in the Middle East as contributing to heightened uncertainty in their economic outlook.  Although this was the Powell’s final meeting serving as Fed chair, he has announced his intentions to remain on the Fed’s board after his term as chair ends.  Powell could potentially remain in place as a governor until that term ends in 2028.  The Fed does not meet again until June 16-17, when Kevin Warsh will host his first meeting as the new chair.

Last week, the markets shifted their focus from day-to-day geopolitical tensions to Kevin Warsh’s testimony to Congress.  The markets and Congress are both looking for indications of the independence of the Fed with Warsh acting as Chair.  However, after the Department of Justice dropped its criminal investigation into the current Chair Jerome Powell, Senator Thom Tillis announced his plans to support Warsh’s nomination.  It is notable that as the market transitions from Powell to Warsh, the rate-path has remained essentially unchanged.  Markets are currently anticipating Warsh will proceed as the next Federal Reserve chair with his first meeting acting as Chair on June 16-17.  The Fed funds futures market is currently anticipating that rates remain unchanged at this week’s meeting and for the overnight rate to remain essentially unchanged for the next 12-months.

Day-to-day geopolitical tensions continue to weigh on the bond market, despite a ceasefire and the anticipated second round of peace talks.  Oil prices have been very dynamic with the Strait of Hormuz effectively closed, blocking oil shipments and pressuring global prices.  As a result, interest rate volatility in the bond market remains high with inflation continuing to drive rates.  Although last week’s economic calendar was relatively light, sentiment drifted throughout the week between the optimism of peace talks and continued growth concerns.  This week, the independence of the central bank may be tested as Kevin Warsh faces his confirmation hearing tomorrow.  The hearing is particularly important because it is taking place less than a month before the current Chair’s term expires, on May 15.  In addition, there is the potential for a stand-off with Republican Senator Thom Tillis vowing to block the confirmation until a Justice Department investigation is resolved.

Geopolitical concerns continue to weigh on the bond market despite last week’s announcement of a two-week ceasefire between the US and Iran.  This morning, tensions are elevated following a break-down of peace talks in Pakistan over the weekend.  As a result, rate volatility in the bond market remains high with inflation continuing to pressure rates.  Last week’s release of the core personal consumption expenditures index by the Bureau of Economic Analysis for February indicated an increase in prices of 0.4% from January, in-line with analyst expectations.  Last Friday’s release of the consumer price index indicated that inflation surged 0.9% in March, the fastest pace in nearly four years.  Furthermore, spiking fuel and fertilizer prices have economists anticipating continued inflationary pressures.

The capital markets continue to focus on developments in the Middle East, amid heightened uncertainty, as the April 7 deadline for massive strikes on Iranian energy infrastructure looms.  Daily volatility remains high as the market vacillates back and forth from anticipating a relatively short end to the war to threats of intensive and prolonged attacks.  The bond market ended last week with Treasury yields jumping three to four basis points across maturities on Friday, following significantly stronger-than-expected March payrolls data.  The unemployment rate ticked lower from 4.4% to 4.3%, which helped dispel anxieties of a softening labor market.

This morning we were welcomed by green screens as Treasuries advanced following weeks of selling.  Nevertheless, Day-to-day volatility remains high in the fixed income markets with the war in the Middle East continuing to dominate headlines and what the media is referring to as the biggest oil supply shock in history.  The war is now in its second month and the rate cuts investors have been anticipating over the past year are appearing increasingly less likely.  Not surprisingly, pricing in the Fed funds futures market has fluctuated dramatically over this past week with current pricing indicating only the chance of a cut over the next year.

Day-to-day volatility remains high in the fixed income markets with the war in the Middle East continuing to dominate headlines.  At the Fed’s meeting last week, the Committee decided to maintain the target range for the federal funds rate at 3-1/2 to 3-3/4 percent.  The Fed Chair expressed a cautious outlook, noting that current inflation levels are being driven by factors pre-dating the conflict in Iran and estimating that between half and three-quarters of total core inflation is actually tariffs.  In addition, the Chair commented that typically the Fed looks through energy shocks and expects to see inflation improving around the middle of this year.  The current uncertainty has resulted in a choppy Fed funds futures market with current pricing not indicating any rate cuts over the next 12-months.

The war in the Middle East continues to dominate headlines, leading to a high degree of volatility in oil prices and pressuring the stock and the bond markets alike.  The Fed funds futures market is currently indicating the Fed will not adjust the overnight lending rate at its meeting later this week.  Due to the high degree of uncertainty from the war in the Middle East, this is not surprising.  Furthermore, current pricing anticipates the Fed will hold rates steady until January of next year.  

Bond investors are currently asking for more compensation for the risk of holding long-dated Treasuries.  Over the past week, Treasury yields have increased by approximately 16 bps for the 30-year maturity while the extreme short-end, around 1-month, remains virtually unchanged.  Munis have responded similarly, although to a lesser degree, with rates roughly 9 bps higher on the long-end.  However, the largest moves in the municipal scale were in the intermediate maturities from 8 to 12-years.  As a result, municipal/Treasury ratios have become more appealing in the in the 5 and 10-year tenors with ratios on the long-end and short-end becoming more rich, characterized by lower relative yields.  Currently, ratios for maturities shorter than 1-year are back in the 50’s while 30-year munis are now yielding less than 90% of equivalent Treasuries.

The war in the Middle East continues to draw the markets focus as bond traders attempt to manage inventory exposure with oil prices now through $100 per barrel.  Last week’s softening labor market data from the Bureau of Labor Statistics and skyrocketing oil prices have fixed income markets nervous that energy costs could trigger a surge in inflation while constricting economic growth.  Not surprisingly, Fed Funds Futures are now implying only one rate cut over the next 12-months and another cut 12-months later. 

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.