All That Glitters Is Gold

WEEK ENDING 10/10/2025

• Fed rates: to cut or not to cut?
• Are circular AI investments pumping up a bubble?
• Deep dive: correlation of gold to the bond and equity markets

A CITY DIFFERENT TAKE

A data-devoid Federal Reserve cannot be a data-dependent Federal Reserve. The theme for a rate cut has been “cooling of the job market.” The government shutdown started on Oct. 1 and delayed the release of official data that both the markets and the Fed rely on to assess economic conditions. As the shutdown drags on, the administration is threatening federal job cuts and layoffs which Office of Management and Budget (OMB) Director Russel Vought has described as “substantial.”

The minutes to the Sept. 16–17 FOMC meeting highlighted the committee’s lingering inflation concerns. Both of its mandates are in conflict. Notes from the minutes reflect this tension:

“Downside risks to employment had increased over the intermeeting period and that upside risks to inflation had either diminished or not increased.”

If the government shutdown ends in the middle of the month, perhaps the Fed can see both the labor number from September and CPI report. For now, the market is still betting on a rate cut of 25 basis points in October. The bet here could be an upside CPI surprise for the Fed.

As market participants, we are familiar with the idea that circular AI investments could be inflating a bubble. Circular AI investments refer to relationships in which:

• One company (say, a chipmaker) invests in or provides favorable financing to a company that is a big customer of its products.
• That customer, in turn, uses that capital to buy more of the supplier’s products or services.
• This creates a feedback loop, where spending is recycled through parts of the same ecosystem, amplifying the appearance of demand.

The concern is that some of the “demand” created in these deals might be somewhat artificial — i.e. the spending is in part subsidized or engineered, rather than all driven by genuine end-user or commercial demand.

Circular AI investments are raising valid warning flags, increasing the likelihood of a bubble or, at the very least, a sharper correction than market participants currently expect. But as of now, we’re closer to “frothy growth” than an outright bubble bursting. Over the next 12–24 months, the battle will be between expectations and reality: if AI product revenues, margins, and use cases do not scale fast enough, you could see sharp investor pullback.

Finally, in light of gold flirting with $4,000 an ounce, we investigated its correlation to stocks and bonds.

Boom Periods (Expansion, Bull Markets)

Busts (Recessions, Market Crises)

Empirical Averages (Historic Data)

Gold has historically been seen as a weak diversifier; it may even fall as yields rise. Gold shines in a recessionary environment and has a negative correlation to stocks, positive to bonds.

Gold’s role improves when real yields fall or inflation surprises to the upside. So how do we explain gold’s rise in the last few years? Gold is classically viewed as a “refuge” asset in times of uncertainty. In 2025, many macro and political risks are higher than usual, which is pushing capital into gold as a hedge. Because gold is priced in dollars, a weaker dollar makes gold cheaper for holders of other currencies, boosting foreign demand. Central banks have been active buyers of gold to diversify reserves away from U.S. dollar exposure or reduce reliance on sovereign debt. That adds a structural source of demand. Persistent inflation erodes purchasing power of fiat money, so gold — being a hard asset — gets bid.

CHANGES IN RATES

Treasury Market

Treasury rates moved lower on the week. The 2/10-year spread lowered by 5 basis points to 53 basis points.

Municipal Market

In the municipal market, the muni curve has been flattening. The 2/10-year spread flattened, moving to 0.52% from 0.65%.

Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio

Treasury-muni ratios were cheaper for last week.

Investment Grade Corporates

Investment grade corporate bond yields moved slightly lower week over week.

THIS WEEK IN WASHINGTON

There are signals that the government shutdown could end soon.

First off, insurers are sending notices of sharp premium hikes this month, where open enrollment begins November 1. This may pressure the Republicans to soften their stance and extend the expiring tax credits as part of a bill.

Secondly, as chaos caused by the shutdown builds at U.S. airports, the likelihood of a bill being passed increases. It turns out air traffic controllers and TSA employees are key to air travel. Who knew?

Positive developments have been made regarding the OMB's request that the Bureau of Labor Statistics recall workers and release the Consumer Price Index on Oct. 24. This is because CPI is an important ingredient in COLA adjustments for Social Security.

One of the triggers that could have forced Congress to act appears to have been removed. Trump directed the Pentagon to use “all available funds” to avoid missed payments to active duty military on Oct. 15. This will not apply to the hundreds of thousands of federal workers who have been furloughed.

The administration froze $26 billion in funding for programs in Democratic-leaning states (transit projects, green energy grants, etc.) as leverage during the standoff.

Finally, the White House announced a 100% tariff increase on China in response to actions around rare minerals and tensions in diplomatic relations. However, after a sharp drop in the equity markets this Friday, the Trump administration signaled an openness to a deal with China. Vice President Vance called on Beijing to “choose the path of reason” in the trade fight.

WHAT, ME WORRY ABOUT INFLATION?

The 5-year Breakeven Inflation Rate finished the week of Oct. 10 at 2.25%, 3 basis points lower than the previous week. The 10-year Breakeven Inflation Rate finished the period at 2.30%, 3 basis points lower than last week's observation.

MUNICIPAL CREDIT

Last week's 10-year quality credit spread between BBB revenue and AAA general obligation bonds was at 0.91% versus a historical average of 1.68%, demonstrating very healthy and tight spread metrics.

TAXABLE CREDIT

Investment grade spreads are tight at 0.97%, 6 basis points wider than last week. This is still very tight compared to a historical average of 1.57%. The high-yield spread is lower at 2.61%, compared to a historical average of 4.57%. We believe that both these markets are overpriced on a spread basis.

WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?

Money Market Flows (millions of dollars)

Money market fund flows were up last week.

Mutual Fund Flows (millions of dollars)

Mutual fund flows were lower from the prior week.

ETF Fund Flows (millions of dollars)

ETF taxables were lower over the week with a net inflow into Municipals.

SUPPLY OF NEW ISSUE BONDS

This week’s tax-exempt market is expected to reach approximately $13 billion.

CONCLUSION

The dysfunction in Washington continues. But there could be a reopening of the federal government considering the increased chaos at airports and missed paychecks starting 10/15. China and U.S. tariff posturing caused the equity markets to sharply decline on Friday, with the White House trying to backpedal in the dance with China. The Fed is still stuck between a rock and a hard place in the middle of its easing cycle without any data to rely on.

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