In a surprise to virtually nobody, the Fed’s 25 basis point cut last Wednesday was met with an immediate rally in rates, testing the 4.00% threshold before retracing and closing higher on the day. As ...
We can expect the unexpected; however, it’s hard to prepare for it and even more difficult to predict what will happen next. President Trump is making progress on his efforts to appoint Fed officials ahead of the next FOMC meeting on September 17. The Senate Banking Committee announced plans for a hearing this week to fill the vacancy from Adriana Kugler’s decision to step down. Stephen Miran is expected to ascend to the position as Democrats lack the votes to block his nomination. Last Monday, however, Trump’s announcement to fire Lisa Cook for cause for alleging falsifying a mortgage application created quite the kerfuffle. How this development shakes out remains to be seen, as she quickly responded with a lawsuit challenging Trump’s effort to remove her, and an emergency hearing was held on Friday in a Washington court. No ruling, however, is expected until after the holiday weekend.
As political melodrama continues to play out, the markets continue along their respective paths. The S&P 500 made a new all-time high, eclipsing 6500. The bond market bull steepened with the front-end moving lower, pushing with a slightly more muted response for longer tenors on the curve. Dovish expectations continued throughout the week, following through with the positive sentiment unleashed at Jackson Hole by Chair Powell the previous Friday. Spreads for both 2s-10s and 2s-30s widened, approaching the steepest curve in over 3.5 years. Despite the increased expectation for impending cuts to the Fed Funds rate beginning in September, longer-end interest rates are grappling with concerns about the rising federal deficit, threats to Fed independence, increased term premium, and ongoing inflation concerns.
As indicated last week, my expectations for zero cuts from the Fed in 2025 have evaporated as the make-up of the Fed and tone of commentary has shifted decidedly more dovish, with concerns about employment taking center stage ahead of inflation. The threat of stagflation for the economy, with slowing growth but still elevated inflation, appears to be presenting more directly than it has in the recent past. I remain cautiously optimistic that the Fed can thread the needle of a soft landing; however, the looming specter of stagflation must be acknowledged.
From the Municipal Desk (with contributions from Ryan Riffe):
It was a quiet but steady week in the municipal market as we approached the long holiday weekend. The MMD scale remained unchanged for most of the week, with a modest adjustment on Friday showing a slight cut to the front end and a bump on the long end. Consecutive weeks of below-average new issue supply have continued to push buyers into the secondary market, creating a more competitive environment. The front end of the curve remains rich relative to Treasuries, which has led to increased interest further out the curve. Both street and customer accounts are showing a greater willingness to take on duration risk, where valuations are notably more attractive. Looking ahead, the market is expected to price in just under $8 billion in new issuance next week, consistent with the levels we've seen over the past few weeks. After 15 consecutive weeks of positive fund flows, the pattern reversed last week with outflows of $732 million exiting tax-free mutual funds. The cyclical nature of the municipal market is exemplified by the sharp change from the prior 3 months of heavy reinvestment money, between $55 billion and $61 billion. Over the next 3 months, reinvestment cash drops sharply between $33 billion and $35 billion. We can likely expect the usual underperformance of the asset class as we head into the early parts of the fourth quarter based upon the fundamental supply/demand dynamics.
Municipal Ratios as Percentage of Treasuries:
2-Yr 60%
3-Yr 60%
5-Yr 63%
10-Yr 76%
30-Yr 94%
An index is unmanaged and not available for direct investment. Definitions sourced from Bloomberg.
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