WEEK ENDING 12/12/2025
- Federal Reserve nears policy pause after "insurance cuts"
- Mixed economic signals and upcoming key data
- Uneven global policy and US fiscal concerns
A CITY DIFFERENT TAKE
The Federal Open Market Committee (FOMC) delivered an expected interest rate cut of 25 basis points, bringing the federal funds rate to 3.5%–3.75%. However, Chair Powell strongly signaled that the period of "insurance rate cuts" is over, suggesting a reluctance to ease further unless the labor market shows more "worrying signs." This hawkish tone was reinforced by two dissents in favor of holding rates steady and Powell's repeated mention of the "neutral rate," implying policy is now close to a level that neither stimulates nor restricts growth. While the market still anticipates one more cut in January, the Fed's new forward guidance (referencing the "extent and timing" of further cuts) is similar to language used before its previous extended pause. Separately, the Fed initiated Reserve Management Purchases (RMPs) of T-bills at a pace of $40 billion per month, stressing that this is a technical move to maintain bank liquidity and not a return to quantitative easing (QE).
The incoming economic data presents a mixed picture, complicating the Fed's next move. On the one hand, strong September trade and inventory data led to an upward revision of Q3 GDP growth, tracking to 3.5%, which is above most estimates of potential growth and suggests that policy may not yet be restrictive. On the other hand, the labor market is showing signs of softness, with the unemployment rate rising by a full percentage point over the 30 months leading up to September. Next week's release of the November employment report is expected to show steady payrolls but a rise in the unemployment rate to 4.5%. Additionally, the November CPI report is forecast to show a 0.3% rise in both headline and core inflation. The market is also focused on the competition for the next Fed Chair, with former Fed Governor Kevin Warsh now reportedly the frontrunner over NEC Chair Kevin Hassett.
The Fed's pause comes amidst a period of uneven global monetary policy. Next week is expected to feature a diverse set of actions, including a forecast rate hike by the Bank of Japan (BoJ) to 0.75%, a resumption of rate cuts by the Bank of England (BoE), and the European Central Bank (ECB) remaining on hold. Furthermore, the growing U.S. budget deficit is emerging as a significant factor in determining longer-term interest rates. The trailing 12-month deficit was 5.27% of GDP as of November. Although fiscal 2026 is projected to be the first year since 2019 with a deficit-to-GDP ratio under 5% (a critical threshold for debt manageability), the need for increased government borrowing globally is expected to affect interest rates in the coming year.
CHANGES IN RATES
Treasury Market
The Treasury yields increased marginally in all tenors. The 2/10 spread is at 66 basis points for the week.
Municipal Market
Yield remained range-bound in the muni market, with the 30-year yield rising the most. The 2/10 slope is at 23 basis points, which is still very flat.
Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio
Treasury-muni ratios were slightly lower across the yield curve because of a higher Treasury yield curve and relatively unchanged yields for the muni curve.
Investment Grade Corporates
Investment-grade corporate bond yields moved higher week over week.
THIS WEEK IN WASHINGTON
The past week in D.C. was dominated by major action on the annual defense bill, key developments in healthcare policy, and new executive moves on technology and immigration.
The looming expiration of the enhanced premium tax credits under the Affordable Care Act (ACA) at year-end was a major point of policy gridlock. House Republicans unveiled a healthcare plan that did not include an extension of these enhanced tax credits, proposing an alternative strategy for health insurance coverage. This sets up a clash over how to address sharply rising health insurance premiums for millions of Americans.
The House of Representatives passed the annual National Defense Authorization Act (NDAA) on December 10, the key defense policy legislation that directs spending for the military. The Senate is expected to pass the measure as well, following a period of bicameral disagreement.
President Trump signed an executive order to limit state-level regulations of Artificial Intelligence, seeking to establish a national policy framework for the technology.
The administration announced $12 billion in "Farmer Bridge Payments" to support American farmers impacted by unfair market disruptions, utilizing existing legislation to facilitate this aid.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of Dec. 12 at 2.32%, 2 basis points lower than the previous week. The 10-year Breakeven Inflation Rate finished the period at 2.26%, same as last week's observation.
MUNICIPAL CREDIT
Last week's 10-year quality credit spread between BBB revenue bonds and AAA general obligation bonds was 0.92%, same as last week compared to a historical average of 1.68%, demonstrating very healthy and tight spread metrics.
TAXABLE CREDIT
Investment-grade spreads widened a bit at 1.01%, 3 basis points higher than last week. The long-term average is 1.57%. The high-yield spread is higher at 2.63%, compared to a historical average of 4.56%.
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Money market fund flows were lower in the tax-exempt category, however, higher in the government and prime categories.
Mutual Fund Flows (millions of dollars)
Mutual fund flows in total were up week-over-week.
ETF Fund Flows (millions of dollars)
Net ETF flows were lower than the week before with taxable bonds being the only positive category.
SUPPLY OF NEW ISSUE BONDS
This week’s supply is projected to be $6 billion. This comes up against $9 billion of coupon reinvestment.
CONCLUSION
The past week marks a significant pivot in U.S. monetary policy, with the Federal Reserve ending its "insurance cut" cycle and signaling a new period of caution as the federal funds rate approaches the estimated neutral range. This shift is complicated by conflicting economic signals: robust Q3 GDP growth suggests strength, while indicators like the rising unemployment rate and downward trend in quits from the JOLTS report suggest an underlying softness in the labor market.
Looking ahead, the direction of U.S. policy and the Fed's next move hinge entirely on next week's crucial data releases, including the employment reports and the CPI inflation reading. Globally, this U.S. policy pause contrasts with divergent actions from other central banks (like expected hikes in Japan and cuts in the UK). Finally, domestic fiscal policy — specifically the large and persistent U.S. budget deficit — remains a growing concern that is projected to exert pressure on longer-term interest rates in the coming year, regardless of the Fed's near-term decisions.
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