The Iran conflict seems to have reached an uncomfortable stalemate. Oil prices climbed this week; WTI Crude Future prices are up $6.88 on the week, hitting $104.95 on Friday. Energy inflation will be driving the overall inflation picture and hopes for a quick resolution to the Iran conflict and fading, at least this week. The time to restore normal oil production could take months once the Iran conflict is resolved.
“It could take at least seven months for the world’s oil production to recover once the Strait of Hormuz reopens, market analysts warn — meaning that higher fuel prices will likely last through the Midterm Elections no matter when the war ends.” Timing is Everything
The markets received two April inflation reads this week and they were not pretty. Month-over-month CPI was 0.6%, down from 0.9% in March. Month-over-month core CPI was 0.4% versus a March read of 0.2%. The difference between the two shows the impact of food and energy inflation on consumers. Although it is lower than the March shock, we feel it is still significant. The year-over-year readings were similar. April YoY came in at 3.8%, higher than March’s 3.3%. YoY core CPI in April was 2.8% — also higher than March’s 2.6%.
Producer inflation was similar, year-over-year final demand was 6.0%, versus an upward revision for March of 4.3%. Core PPI was 5.2% versus an upwardly revised March number of 4.0%. All well above the Fed’s 2.0% target. The Iran conflict is driving the cost of energy higher and access to energy product is impacting Asia more than the United States — but we get a lot of inputs form Asia so costs are passed through.
On Wednesday, Kevin Warsh was confirmed by the Senate as the new Federal Reserve chair. (Jerome Powell is staying on as a voting member until all the DOJ investigations are resolved.) As we have highlighted in previous pieces, Chair Warsh favors a different inflation measure than the Fed’s core PCE measure. That measure is the Dallas Fed’s trimmed mean PCE and the Cleveland Fed’s median PCE.
So, what is the Dallas Fed’s trimmed mean PCE measure?
“The threshold above and below which items are dropped, or trimmed, varies across estimators. The Federal Reserve Bank of Dallas’ trimmed mean PCE inflation rate excludes components whose share of total expenditures falls below the 24th percentile or above the 69th percentile of the price change distribution. In February, for example, the Dallas Fed dropped telephone and related communication equipment (with an annualized one-month price change of -50.8%) and moving, storage, and freight services (with an annualized price change of +384.6%). So, while the headline PCE measure rose by 2.8% for the 12 months ending in February 2026, and PCE excluding food and energy rose 3.0%, the trimmed mean rose 2.3%.” New Chair, New Inflation Measure
The following graph shows the differences between the Dallas trimmed mean core PCE measure and the Fed’s core PCE measure monthly and a moving 3-month average basis:
The histogram chart illustrates that the majority of the difference between the Dallas trim mean core PCE measure and the core PCE inflation measure falls in the -0.05% to 0.25% range. This means that over the last 20 years the Dallas trim mean core PCE inflation measure has more observations slightly above the core PCE measure.
We have taken a deeper look at the Dallas trimmed mean measure for the last 20 years and compared it to core PCE, calculated some of the differences and its impact on 10-year real yield measures (a value matrix). The table below summarizes our findings.
When one looks at the long-term difference between the two measures as an average of 3 basis points, one might think what is the whole hullabaloo about? Well, averages can hide a lot. Think of the old economist’s saw. If you have your head in the oven and your feet in the freezer, on average, you are okay. But when we look at the relative real yields the two measures produce, the Dallas trim mean core PCE measure gives the Fed more room to ease interest rates.
The market’s implied probabilities of a rate cut have vanished. The last implied probability of a rate cut is a mere 3.3% at the June meeting. After that, all the implied probabilities are for a rate increase for the remainder of the year. These implied probabilities are in line with three of the four descents at the last Fed meeting.
President Trump returned from his China visit. But was it productive? The headlines reveal a mixed bag:
“Trump wraps up warm China trip with few clear wins” NBC News
“Trump leaves China, short on deliverables but with signs of a stabilized Relationship” CNN
Both the fixed-income and equity markets seemed to ignore this week’s inflation releases, maybe hoping for a significant announcement from the president’s trip to China. On the week through Thursday’s close the 10-year Treasury bond increased in yield/lowered in price by +0.07%. As of Friday’s close, the 10-year Treasury bond is up 0.12% in one session. The S&P 500 index was higher by 1.19% through Thursday’s close. On Friday the S&P 500 was down 1.24%. A “Minsky” moment? Perhaps it’s because the president and his entourage returned to Washington, but it’s too early to tell. Ahh, sweet mysteries of life!
CHANGES IN RATES
TreasuryMarket
Treasury yields moved significantly higher on the week. The 5-year and 30-year Treasury securities ended the week at a one-year high. Most of the reaction came about on Friday, days after the release of the latest inflation readings. The 2/10 spread widened buy a couple of basis points going from 48 basis points to approximately 50 basis points this week.
Municipal Market
AAA general obligation municipal bond yields were higher on the week but lagged the Treasury market move. The municipal market may be susceptible to some catch-up in the coming week. The 2/10 spread barely moved, ending the week at 0.52% versus last week’s 0.51%.
Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio
The muni/Treasury ratios are through the current breakeven rate of 67% (highest marginal tax rate). Ratios mostly moved lower on the week due to the municipal market yield adjustment lagging the Treasury market yield adjustment.
Investment Grade Corporates
IG Corporate yield adjustments were more in line with Treasury market yield adjustments. Corporate quality spreads did not move. The 2/10 spread is 96 basis points.
See above for coverage of the two biggest things impacting the economy this week: the president’s trip to China and the confirmation of Kevin Warsh.
The 5-year Breakeven Inflation Rate finished the week of May 15 at 2.70%, 8 basis points higher than last week. The graph above contrasts a 5-year Breakeven Inflation Rate (this is the market-implied inflation rate) tracked weekly versus the core PCE inflation rate. The 10-year Breakeven Inflation Rate finished the period at 2.49%, 4 basis points higher than last week.
Last week's 10-year quality credit spread between BBB revenue bonds and AAA general obligation bonds was 0.81%, virtually unchanged week over week. The historical average credit spread is 1.67%.
Investment-grade spreads for the past week were at 94 basis points, 3 basis points lower than the previous week. The long-term average for investment grade is 1.56%. High-yield credit spreads are 2.65%, 4 basis points higher than last week.
Money Market Flows (millions of dollars)
Money market fund flows were positive overall but close to flat in total. There is $7.7 trillion sitting in money market funds, which remains a significant opportunity. This is much higher than the $6.9 trillion sitting in money market funds on May 14, 2025.
Mutual Fund Flows (millions of dollars)
Mutual fund flows were positive overall. Just when you thought it was safe to go in the pool, days like Friday happen. It is impossible to pick market tops or bottoms.
ETF Fund Flows (millions of dollars)
Net ETF flows were positive week over week. It doesn’t matter which investment vehicle; it is impossible to pick tops or bottoms.
Supply continues to dominate the muni market. The tax-exempt calendar is projected at $12 billion this week. A big week before the Memorial Day holiday and the start of summer, not to mention the season in which the municipal market tends to outperform other fixed-income markets.
Just as the conflict in Iran impacts the energy markets, inflation drives market performance. The markets’ initial reaction to the hot inflation releases seemed to lag by a couple of days. Maybe market participants were waiting for significant announcements from the president’s China trip. Friday’s moves in both the stock and fixed-income markets highlighted participants’ disappointment. Add to the mix the confirmation of Kevin Warsh as the new Fed chair and the volatility stew just got a little hotter. In a recent opinion piece in Barron’s, “Kevin Warsh and the Return of Monetarism,” the author illustrates the conflict of Warsh’s two key goals: 1) lower short-term interest rates and 2) shrink the Fed’s balance sheet.
“Warsh has suggested that monetary policy tightening by reducing the balance sheet will allow the Fed to lower interest rates to the benefit of all Americans, not just those who own the financial assets targeted by QE. He is right: While balance sheet reduction by draining funds from the banking system will cause money growth to slow, lower interest rates implemented by injecting funds back in will cause it to accelerate. And you Thought the Fed's Dual Mandate was Hard to Manage
Summer is upon us and the market’s volatility will give market participants something to worry about.
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