All eyes were fixed on last Wednesday's FOMC rate decision and Chair Warsh's accompanying press conference. As expected by yours truly, the Committee held the Fed Funds target range steady at 3.50% to 3.75%. Markets, however, reacted negatively, particularly following a press conference that did little to instill confidence. Arguably, the Fed's new communication approach, which places less emphasis on forward guidance, is taking time for investors to digest.
The result has been the introduction of an uncertainty premium and heightened volatility that were largely absent during the tenures of Powell, Yellen, and Bernanke.
In my view, the market granted Warsh a one-time pass during his inaugural FOMC press conference. Unfortunately, his delivery was stilted and failed to establish ownership of either the message or the Committee. His suggestion at his second press conference that financial markets are doing part of the Fed's job is a dangerous proposition if it becomes a guiding philosophy. Equally concerning was his unwillingness to provide clarity around the inflation measures the Fed intends to emphasize going forward, beyond a suggestion that Personal Consumption Expenditures (PCE) will continue for the time being. Rather than offering a framework, he deferred the conversation to future task force recommendations, effectively kicking the can down the road.
Investors responded accordingly. Treasury markets sold off aggressively, pushing 30-year yields to their highest levels in nearly two decades and driving the 10-year Treasury yield above 4.70%. Equities suffered a meaningful setback as confidence in the Fed's communication strategy deteriorated.
Meanwhile, geopolitical developments and the conflict with Iran continue to loom in the background as central bank policy took center stage last week. Brent crude oil fell sharply from roughly $100 per barrel at the end of the prior week to as low as $82 as reports of diplomatic progress and several days of reduced escalation between the United States and Iran removed a significant portion of the geopolitical risk premium that had accumulated in recent weeks.
Investors should resist the temptation to assume that the recent decline in oil prices marks the end of the story.
Since the conflict began, markets have repeatedly interpreted temporary de-escalation as a precursor to a lasting resolution, only to be proved wrong. As such, volatility and a persistent uncertainty premium are likely to remain embedded in energy markets for the foreseeable future.
An often-overlooked factor is the state of the U.S. Strategic Petroleum Reserve, which has fallen to its lowest level since 1983. That is not a typo. At some point, policymakers will need to replenish emergency inventories to restore a more appropriate level of supply security. Should the end of the conflict trigger a euphoric decline in crude prices, the prospect of SPR replenishment would create an additional source of demand that should ultimately provide support for oil prices.
As noted above, interest rates have reacted sharply, and the higher-for-longer narrative remains firmly intact. It is important to remember that central banks directly influence the front end of the yield curve through the overnight Fed Funds rate. The long end of the market, however, remains in the hands of bond investors.
When confidence in the Federal Reserve's ability, willingness, or strategy is called into question, the bond market responds by demanding higher yields.
That dynamic is playing out in real time. With the 10-year Treasury yield closing around 4.70% on Friday, a retest of the January 2025 high near 4.80% appears increasingly likely. A decisive move above that level would shift focus to the October 2023 peak near 5.00%, a threshold that would have meaningful implications across fixed income, equities, and broader financial conditions.
Contributions from Ryan Riffe
A choppy week capped what has been a volatile month of July for municipals. Strong seasonal demand and positive fund flows allowed the momentum from June to carry nicely into the early part of the month. That trend, however, reversed when renewed U.S.-Iran tensions pushed oil prices and Treasury yields higher. Adding to the pressure, Fed Chair Kevin Warsh left rates unchanged while adopting a hawkish tone that sent intermediate and long-end Treasury yields sharply higher. There was nowhere to hide in the municipal market, which surrendered much of the strength it had built during the first part of the week.
Friday's close could not come soon enough for market participants. July is shaping up as one of the weakest July performances for municipals in decades. Fifteen-year maturities have borne the brunt of the selloff, with yields rising 41 basis points month-to-date. By comparison, front-end yields have increased 22 basis points, while long-end yields have climbed 30 basis points.
Although August has historically been a favorable month for municipal bond performance, many of the headwinds that weighed on the market in July remain firmly in place. Compounding those challenges, next week's new-issue calendar is expected to approach $18 billion, well above the year-to-date weekly average of $10.5 billion. The combination of elevated supply, higher Treasury yields, and lingering geopolitical uncertainty could make for another challenging backdrop as the market turns the page to August.
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