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WEEK ENDING 9/12/2025
- Market expects Fed to cut rates this week by 25 basis points
- A weakening labor market overshadows inflation for the Fed
- A short dive into the Fed’s history reveals the 2% inflation mandate is recent
A CITY DIFFERENT TAKE
This week’s Fed rate cut is cemented in the market's eye.
The Federal Reserve’s target rate is currently at 4.5%, with a near 100% probability of a 25-basis-point rate cut for Wednesday. This will be the first cut under the Trump administration. A rate cut will resume the cycle from last year, when the Fed cut rates by 50 basis points in September and a quarter-point in November and December. It is important to note that in January of this year, the Fed communicated that they were “pausing” the trajectory of rate cuts rather than ending it.
A brief examination of inflation and employment before the Fed meets:
The headline CPI in August rose by 0.4%, reflecting an annual increase of 2.9%. The increase in CPI was driven by a 0.45% rise in food prices. Core CPI, which strips volatility of food and energy prices, also rose by 0.34% for the fourth consecutive month. At 2.9% this is the highest YoY CPI number since Jan. 2025.
We at City Different Investments think that inflation numbers won’t deter the Fed from cutting 25 basis points this week. Remember that there are differences in how CPI and Personal Consumption Expenditure (PCE) are calculated. Because of the difference in methodology, CPI tends to run higher than core PCE.
If we look at monetary history, certain trends emerge:
- 1970s–early 1980s: CPI surged above PCE due to oil shocks.
- 1990s–2010s: Both measures moderated near 2%.
- 2021–2022: Biggest divergence since 1980s, with CPI peaking >8% vs. core PCE ~5%.
The consensus thinking around tariffs has been that these are going to be one-time price increases and should not cause sustained inflation. However, the impact still needs to play out, given the front-loading of buying by corporations and consumers alike for 2025.
The labor market added an average of 29,000 jobs in the last three months. This week saw a massive revision to March’s employment data. The number of workers on payroll for twelve months through March was revised down by a staggering 911,000. The revision showed an average monthly job growth of around 150,000 per month.
The Fed indicated it is “shifting away” from worrying about inflation to worrying about the labor market. When the Federal Reserve was created in 1913, it was with the mission of providing financial stability and being a lender of last resort.
Congress passed the dual mandate in 1977. Congress also amended the Federal Reserve Act (Humphrey-Hawkins Act, formally the Full Employment and Balanced Growth Act of 1978, but the key language was passed in 1977).
Since then, the Fed’s statutory goals have been:
- Maximum employment
- Stable prices
- Moderate long-term interest rates
This is commonly called the dual mandate (employment + inflation).
Another nugget from spelunking into the Fed’s history is that an explicit 2% inflation target was officially adopted in 2012 under Chairman Bernanke. The Fed formally adopted a 2% longer-run inflation goal (measured by the PCE price index), which was published in the Fed’s “Statement on Longer-Run Goals and Monetary Policy Strategy.”
CHANGES IN RATES
The front end of the Treasury market shows the full pricing-in of a 25-basis-points rate cut. The 2/10-year spread ended the week at 51 basis points, a bit flatter than last week.
The municipal market rallied similarly to the Treasury market. The muni curve has been flattening. The 2/10-year spread in the muni market flattened to 0.86%.
Treasury-muni ratios decreased throughout the week reflecting the flattening of the curves.
Investment grade corporate bond yields moved slightly lower week over week. The front end of the curve did not move much with the longer end flattening.
THIS WEEK IN WASHINGTON
The jury is still out on the legality of the International Emergency Economic Powers Act that the president used to impose tariffs. A Supreme Court ruling against the White House could lead to unprecedented circumstances and confusion.
President Trump’s tariffs have generated a new cash stream for the Treasury Department, creating $165 billion in customs duties for FY2025. The loss of this revenue will further widen the budget deficit. The budget gap for the first 8 months of 2025 is at nearly $2 trillion. In other words, more than 6% of GDP. The long end of the Treasury curve carries the “term premium” pricing of the growing deficit. But the bond market is currently preoccupied with the shorter tenors and the Fed’s rate cut (for now).
Recently, long-end Treasury bonds have been facing pressure. Rising yields are flashing a warning to the government about concerns over debt and deficit.
The U.S. and China have started a new round of economic talks in Madrid. Treasury Secretary Bessent is leading the U.S. delegation.
Much closer to home, last week witnessed the killing of conservative activist Charlie Kirk. The accused is a 22-year-old student from Utah. Kirk’s death has triggered debates about political violence and concerns about free speech and polarization.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of Sept. 9 at 2.46%, 4 basis points higher than the previous week. The 10-year Breakeven Inflation Rate finished the period at 2.36%, 1 basis point lower than last week's observation.
MUNICIPAL CREDIT
The 10-year quality credit spread between BBB revenue less AAA general obligation bonds for last week was at 0.91% versus a historical average of 1.68%, demonstrating very healthy and tight spread metrics.
TAXABLE CREDIT
Investment grade spreads are extremely tight at 0.80%, compared to a historical average of 1.11%. The high-yield spread is lower at 2.65%, compared to a historical average of 4.6%. 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 mixed last week.
Mutual Fund Flows (millions of dollars)
Mutual fund flows were mixed last week with municipals and high yield experiencing net outflows.
ETF Fund Flows (millions of dollars)
ETF asset classes saw a net decrease in flows over the week.
SUPPLY OF NEW ISSUE BONDS
This week’s tax-exempt market is at $4.4 billion, remarkably smaller than earlier weeks.
CONCLUSION
Inflation remains elevated, and PPI prints are soft for the month. Due to the weakening labor market, the Federal Reserve is widely expected to cut rates by 25 basis points.
IMPORTANT DISCLOSURES
The information and statistics contained in this report have been obtained from sources we believe to be reliable but cannot be guaranteed. Any projections, market outlooks or estimates presented herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice.
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