At the time of this writing, 10-year U.S. Treasury is at 3.93%. Earlier, on Feb. 11, the note was at 4.18% (25 basis points higher). At this time of heightened global conflict, investors have found comfort in the safety of the Treasury market. Not only does this weekend’s attack on Iran show the strength of the Treasury market, but it also shows the correlation between equity and the fixed-income markets. Why the Iran Attack Proves Bonds Are Still a Safety Net - Barron's
Fixed income is behaving exactly as it should. Post “Liberation Day,” the sell-off in Treasury and the breakdown in correlation shook investors’ confidence. Check out the latest CDI blog, Are Treasuries Still Safe? for more.
Before the newest conflict in the Middle East, the market was already grappling with two uncertainties: the Supreme Court’s decision to strike down International Emergency Economic Powers Act (IEEPA) and AI's impact on SaaS and equities. In both these scenarios, the 10-year Treasury did not show a pulse. We think the reason behind this was the legacy SaaS scared equity money parked in the bond market. However, as the week unfolds, any long-lasting oil conflict and resultant oil price shock to the upside might result in a steeper Treasury curve. Private-credit ‘cockroaches’ and the AI ‘scare trade’ hammered stocks in February. Here’s what else has investors shaken up. - MarketWatch
With regards to tariffs, it’s a massive “wait-and-see” game. Investors are staring at a huge legal void. Even though the Supreme Court struck down the use of the IEEPA for tariffs, the sectoral tariffs — the ones targeting specific industries — are still standing. They haven't moved. But we’re seeing U.S. trading partners like the EU and Japan hitting the pause button. They’re reassessing all those compromises they made with the administration over the last year because, frankly, the legal ground just shifted. The big question is how the new proposals might violate or complicate existing agreements. It’s not just a policy shift; it’s a credibility check for every deal currently on the table.
The market is zeroing in on the funding gap. We finished 2025 with a $1.8 trillion budget gap — roughly 6% of GDP, projected to hit 7% or 8% over the next five years. This $170 billion refund isn’t just a legal headache; it’s a one-time funding need that the Treasury likely has to cover by issuing more T-bills. This acts as stimulus for the economy which leads to higher inflation with an increasing deficit causing a steeper yield curve. The “Liberation Day” ruling basically biased us toward higher long-term rates because investors realized the fiscal gap is only widening. Plus, these Section 122 tariffs have a strict 150-day expiration date. So, we have five months of this 10% (and potentially 15%) levy before the administration scrambles for a new legal hook, like Section 301 investigations. It’s a temporary patch on a long-term fiscal leak.
The “true” high-yield risk isn't even in the public bonds anymore; it’s being parked in private credit.
It completely changes the risk-reward profile. We’ve been living in a world where public high-yield spreads are anchored near 260 basis points — multi-decade tights. But that’s because the riskiest, most leveraged companies aren't issuing public bonds anymore. They’re going to private direct lenders. UBS just hiked its worst-case default forecast for private credit to 15%, specifically citing “rapid, severe AI disruption” in the software sector. Remember, about 40% of sponsor-backed loans are in software. If AI eats the business models of these legacy SaaS companies, you aren't just looking at a few defaults — you’re looking at a sector-wide meltdown. The “cockroaches” Jamie Dimon warned about are starting to come out of the walls, and the first place they’re appearing is in the private markets that don't trade every day. Even if the public market looks healthy today, it’s tethered to a $1.8 trillion private market that is currently undergoing its first real stress test since 2008. If the private wheels come off, the public spreads will have no choice but to widen aggressively to catch up to reality.
Beyond sensational news overload, there’s the boring nitty-gritty of the fixed-income market. One such print is the Producer Price Index (PPI), which rose more than expected in January. In normal conditions, this would be an alarming increase. The headline rise in PPI is at 0.5%. Year-over-year, the core PPI increased 3.6% in January, again surpassing the 3.0% gain expected and marking the largest gain since March. PPI is the reason core PCE (the Fed’s favorite measure of inflation) is diverging from CPI, which has moderated to 2.5%. Core PCE still stands at 3%.
A reminder: Governor Cook, Minneapolis Fed Char Kashkari, Dallas Fed President Logan, and Cleveland Fed President Hammack are uncomfortable above target inflation and on the hawkish side for the Fed.
TreasuryMarket
The Treasury market rallied on Friday. The two-year yield dropped 7 basis points to 3.40%. The 10-year yield decreased by 12 basis points as safe-haven trade gripped the market. The 2/10 spread lowered by 3 basis points to 57 basis points.
Municipal Market
The municipal market did not move much. The 2/10 spread for last week is at 47 basis points, 2 basis points higher than the week before.
Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio
Treasury-muni ratios widened across the yield curve.
Investment Grade Corporates
Investment-grade corporate bond yields flattened in the middle of the curve.
Operation Epic Fury started on Feb. 28 when the U.S. and Israel struck targets in Iran, killing Ayatollah Ali Khamenei.
It’s unclear who will succeed in Iran’s power vacuum. Policy analysts are calling this a maximalist strategy.
This week, the war will test the markets. The most direct impact will be in the crude oil market. The likelihood of crude oil going to $80 a barrel is high. The Strait of Hormuz is strategically important. About one-fifth of global oil flow passes through that and if that remains close, there are speculations of a barrel of crude crossing $100. Currently, three ships were attacked near the Persian Gulf, casting a shadow of fear over oil prices.
Most of Iran’s oil goes to China. Currently, China has significant oil reserves. There are speculations whether China would have to buy oil from the U.S.
For now, safe-haven trades like Treasurys and gold are attracting capital.
Tariffs, which seem like news from a year ago, are settling in lower for now at an average effective rate of slightly less than 10%. On Friday, we saw threats to increase this to 15% under Section 122.
The 5-year Breakeven Inflation Rate finished the week of Feb. 27 at 2.40%, 3 basis points higher than last week. The 10-year Breakeven Inflation Rate finished the period at 2.25%, 3 basis points lower than last week.
Last week's 10-year quality credit spread between BBB revenue bonds and AAA general obligation bonds was unchanged for the week at 0.89%. The historical average credit spread is at 1.68%.
Investment grade spreads for the past week were at 89 basis points, 9 basis points higher than the previous week. The long-term average for investment-grade is 1.56%.
Money Market Flows (millions of dollars)
Money market fund flows were largely higher week-over-week.
Mutual Fund Flows (millions of dollars)
Mutual fund flows were mixed for last week.
ETF Fund Flows (millions of dollars)
Net ETF flows were weak, down in all categories.
This is a big muni week with more than $11 billion in tax-exempt calendar issuance.
The Iran conflict dominates the markets and investors' minds for now. The bond market behaved resiliently to private credit scare, a SCOTUS ruling, and even hotter than anticipated PPI prints. For now, the correlation between stocks and bonds is working. However, if the conflict persists and oil prices are severely impacted, we will see Treasury yields rally and a steeper curve. For now, the new effective tariff regime under Section 122 is at an average effective rate of 10% and sectoral tariffs still remain.
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