WEEK ENDING 8/8/2025
- Gov. Waller Fed chair front-runner (for now)
- Tariff rates and revenues keep going up
- Active summer for muni issuance
- Check out Sweta’s recent interview on Trader TV
A CITY DIFFERENT TAKE
The president’s Aug. 1 tariff deadline has come and gone. But trade deals with China, Mexico, and Canada are still up in the air, with the latter two currently being renegotiated.
Over the last month, trade agreements were reached with the EU (15%), Japan (15%), and several other trade partners. Tariff revenues have surged since March, rising above $25 billion in June. Tariff revenues should continue increasing slightly as trade deals settle at higher tariff rates.
Moving to monetary policy, the Fed met about two weeks ago. There were essentially two camps within the Fed: one still worried about tariff inflation, and one increasingly worried about cracks in the labor market. “Wait-and-see” thinking prevailed at the July meeting, with the committee keeping rates steady. But Governors Waller and Bowman dissented in favor of a rate cut. Two days after the meeting, a weak July payrolls report with significant downward revisions to the prior two months intensified concerns about the labor market.
Economic data last week points to a slowing labor market; last week’s initial jobless claims (226,000) came in higher than expected (221,000). Similarly, continuing jobless claims also jumped up for the last week of July. This is the highest level since November 2021.
After six months of inflation taking center stage, the labor market has stolen the spotlight. For June, core PCE (the Fed’s favorite inflation measure) is still above 2%, at 2.8%.
Finally, real GDP growth rebounded to 3.0% in Q2 after a 0.5% decline in Q1. However, most of that growth came from a swing in net exports, while consumption posted its weakest quarters post-COVID. Given the high levels of uncertainty this year, consumers are clearly not in a spending mood.
That’s the backdrop moving forward.
We just learned President Trump chose Stephen Miran from his Council of Economic Advisers to serve as a Federal Reserve governor. Chair Powell has been facing intense pressure from the president to lower rates. In the July meeting, we saw dissents from Trump-appointed Governors Bowman and Waller. With Miran possibly set to be a third dissenter, we see Chair Powell succumbing to pressure for a rate cut.
Media reports indicate that Governor Waller is now the favorite to succeed Powell as Fed chair. Waller is a widely respected policymaker who represents continuity, and markets would likely cheer his nomination.
CHANGES IN RATES
Rates rose in the treasury market. The 2/10-year spread remained at 52 basis points.
Yields in the municipal market were lower throughout the curve. This week, the 2/10-year spread in the muni market was 89 basis points, two basis points higher than last week.
As of Friday, the fixed-income market is assigning a 91.2% probability that the Federal Reserve will cut short-term interest rates by 0.25% at their September meeting, followed by a 66.3% probability of a 0.25% cut at their October meeting and rounding out the year with a 80.75% probability of a 0.25% cut at their December meeting.
Our portfolio positioning is based on finding value. Currently, a five-year Treasury bond yields 89% of a ten-year Treasury bond for about half the duration risk. The long-term average of this relationship is 77%, and for those interested, that is 0.66 standard deviations off the long-term average. You can apply a similar analysis to spread products like IG and munis.
In our fixed-income portfolios, our strategies are as close as possible to duration neutral, so we can remain nimble and act accordingly as volatility plays out for the remainder of the year.
Treasury-muni ratios got more expensive due to rates backing up last week.
Investment grade corporate bond yields moved slightly higher week over week.
THIS WEEK IN WASHINGTON
A week after the Aug. 1 deadline, tariff negotiations are still in full force, including renegotiating India’s tariffs.
The president announced a 100% tariff on semiconductors. A significant discount would be given to companies investing in the U.S., so it may take some time for the effective rate to become clear. As of this weekend, reports have emerged that AMD and Nvidia will pay 15% of their China revenue to the U.S government.
President Trump has asked for Lip-Bu Tan, CEO of Intel, to resign due to his involvement with investments in Chinese companies. The CEO is set to visit the president on Monday.
Moving back to tariffs, pharmaceutical rates could reach at least 150% within 18 months. Secretary Bessent has commented that tariff talks should be behind us by October.
In international news, Israel is facing backlash over its pursuit to forcefully take over Gaza. Arms embargoes, arrest warrants, and cultural boycotts from the international community continue.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of Aug. 8 at 2.32%, three basis points higher than the previous period. The 10-year Breakeven Inflation Rate finished the period at 2.39%, six basis points higher than the observation from last week.
MUNICIPAL CREDIT
As of Aug. 8, the 10-year quality spreads (AAA vs. BBB) were at 0.85% (based on our calculations). The long-term average is 1.69%.
TAXABLE CREDIT
Investment grade spreads are extremely tight at 0.74%, compared to a historical average of 1.11%. The high yield spread is lower at 2.75% versus 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 much higher week over week.
Mutual Fund Flows (millions of dollars)
All asset classes experienced net inflows week-over-week, except high yield.
ETF Fund Flows (millions of dollars)
ETF asset classes saw a net inflow over the week.
SUPPLY OF NEW ISSUE BONDS
Muni issuance has been front-loaded this year and this “Muni summer” is like no other. The muni market recorded two consecutive $50+ billion tax-exempt supply months in June and July for the first time ever. Tax-exempt supply through July totaled $303 billion, exceeding the same 7-month period in 2024 ($253 billion) by 20%, and notably is 55% higher than the trailing five-year average ($196 billion). We are unsure if supply will ramp back up from here and if issuance will continue to run strong through year-end. For this week, tax-exempt muni issuance is slated to be around $10 billion.
CONCLUSION
The job market is showing weakness as we roll into the second half of the year. Tariff negotiations are still ongoing. Secretary Bessent seems to think this will be wrapped up by October. Chris Waller is emerging as the front-runner for Powell’s job. Pressure is also mounting on Powell. In addition to weak economic data, we now have three Fed governors who might dissent because of the politicization of the Fed.
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