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.

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.

US seasonally adjusted initial jobless claims dropped to 217,000 last week, which marks a 3-month low, supporting speculation the Federal Reserve will keep rates unchanged at this week’s meeting.  Currently, the futures market is pricing-in only a 3% chance of a rate cut at this week’s meeting with the first cut of the year not anticipated until October.  However, the job market may not be as robust as it initially appears.  As noted during our Trader’s Strategic Ideas session earlier this month, continued jobless claims have been steadily increasing over the past 3-years, indicating jobless workers are taking longer to re-enter the labor force.  Last week, continued claims increased to 2.039 million, an increase of 113,926 from the prior week and an extension of this longer-term trend.  Following the Fed’s meeting later this week, we hope to have more clarity on the Fed’s assessment of recent employment and inflation data.

Treasuries outperformed munis during this past week, as both markets moved in opposite directions on the long-end.  Although uncertainty remains high, comments from Fed governor Waller supporting a July rate cut have put downward pressure on Treasury rates while the muni market struggles with: weakening fund demand, heavy supply and growing secondary offerings, particularly for maturities beyond the 10-year tenor.  Looking at inflation expectations via inflation swaps, the market’s concerns become increasingly evident with two-year inflation swaps now over 3%, which is a level we haven’t seen since early 2023.  In addition, with potentially higher tariffs being implemented on August 1, inflation anxiety is likely to be a significant factor this week.

Over the past week, a combination of tariff announcements, fiscal deficit anxiety and inflation concerns have driven long-term Treasury and municipal bond yields higher.  Treasury yields past 10-years have generally risen by 3 to 4 basis points while shorter Treasury yields are generally 1 to 2 basis points lower, resulting in a steeper Treasury curve.  The municipal yield curve exhibited a similar steepening with yields under 10-years generally 2 to 4 basis points lower and yields past 10-years generally 3 to 4 basis points higher.  Looking at the 2s10s spread, which is the difference between the 10-year yield and the 2-year yield as an indicator of the steepness of the yield curve, the municipal curve has recently reached the steepest slope in over 2-years.  This is an invitation for bond investors to extend duration.

Last week, the President signed into law his “Big Beautiful Bill,” which reportedly contains roughly $4.5 trillion in tax cuts, and protects the tax exemption for municipal bonds and private activity bonds.  The Bill also creates a new category of private activity bonds for “spaceports” and includes a few additional bond-related provisions.  The preservation of the tax-exemption is of critical importance to the municipal bond market.

Treasury and municipal market yields rallied over this past week as the market fixated on the potential for the Fed to cut rates earlier than previously forecast.  Sentiment was driven by dovish Fedspeak from Fed governors Bowman and Waller, first quarter GDP revisions to -0.5% and a benign May PCE report, all of which bolstered rate cut expectations.  The futures market is now anticipating the Fed could cut rates as soon as September.  However, Fed Chair Powell’s comments made last week to the House Financial Services Committee were clear, that the Fed is well positioned to wait citing elevated inflation and intensifying price pressures.  Powell also commented that signs of weakness in the labor market would change the Fed’s stance.  As a result, we may see some volatility in the capital markets following this week’s employment data releases on Tuesday and Thursday.