Monday marks the 23rd day of the Iran conflict and the markets are reeling. The May contract for West Texas Intermediate is at a one-year high of $96.85 per barrel. The S&P 500 Index is at 6554.17, down from 6,878.88 on Feb. 27 (-4.72%). Both Treasury and municipal 10-year yields are up (meaning lower prices) roughly +0.40% over the same period. (That is a lot for both markets in a short period of time.)
In addition to the Strait of Hormuz being effectively closed, attacks on energy facilities are increasing.
“The attacks on Iran's energy industry in South Pars and Asaluyeh have raised concerns that Iran could also target infrastructure of global energy majors across the Gulf, and alternative regional export routes such as Saudi Arabia’s Red Sea port of Yanbu, prolonging a conflict that has already effectively closed the Strait of Hormuz.” Energy Facility Attacks
This will only add to the recovery time, which could take years by some estimates, adding to the prolonged energy dislocation and inflationary pressures worldwide. Some shorter corrective actions have been taken. What effect they will have is yet to be seen.
“On Thursday, Washington issued a (sic) allowing countries to buy sanctioned Russian crude oil and petroleum products currently at sea. The U.S. Treasury had already issued a similar 30‑day waiver specifically for India.” Remember the “6 Ps”: Proper Planning Prevents Pitifully Poor Performance
In addition, some Iranian oil is being released into the market. (What will they do with the money, buy Russian drones?)
“Treasury Secretary Scott Bessent said on Thursday the U.S. may soon remove sanctions on Iranian oil stranded on tankers at sea, as Washington seeks to curb prices soaring over Iran's closure of the Strait of Hormuz”. Again, Remember the “6 Ps”!
Mission Creep?
“The Pentagon is sending three warships and thousands of additional Marines to the Middle East, even as President Trump insists he won’t put American boots on the ground in Iran, according to U.S. officials. Roughly 2,200 to 2,500 Marines from the California-based USS Boxer amphibious ready group and 11th Marine Expeditionary Unit are heading to the U.S. Central Command, responsible for all American forces in the Middle East, the officials said.” Six “Ps” redux
The Fed Meeting
Now for something on the lighter side. The Fed met this week and left short-term interest rates unchanged. The risk assessment to the Fed’s dual mandate (maximum employment and stable prices) is now weighted to the risks of higher inflation versus slower economic growth (i.e. higher unemployment).
“The labor market, meanwhile, has stalled. Once you adjust for overcounting in previous months, private-sector job creation has effectively flatlined. The February jobs report showed employers cutting 92,000 positions, and the unemployment rate ticked up to 4.4%. Powell said the break-even rate for new jobs is essentially zero, given that labor force growth has all but stopped due to immigration restrictions during the Trump administration.” Employment picture looks OK for now
What about Inflation Pressures?
“Then there’s that war. Oil prices have surged since the Iran conflict began, with Brent crude nearing $115 a barrel and gas prices jumping almost $1 per gallon—raising fresh fears of another inflation spike. Powell acknowledged the oil shock would create ‘upward pressure on inflation’ and ‘downward pressure on spending and employment’ — but said the Fed has no way of knowing how large or lasting those effects will be.
“‘Nobody knows,’ he said. ‘They could be much smaller or much bigger. We just don’t know.’
“Powell rejected the idea that the U.S. is in stagflation — at least for now — and insisted the economy is holding together.” Risk to Stable Prices
What does Powell’s Future Hold at the Fed?
“At a news conference, Powell said he had ‘no intention of leaving’ the Fed until a Justice Department investigation of him is ‘well and truly over, with transparency and finality.’
“Even if the probe does conclude, Powell said, he hadn’t made up his mind about his plans. He suggested that the decision wasn’t personal. Instead, he would focus on doing ‘what I think is best for the institution and for the people we serve,’ he said. It was the first time he publicly discussed his thinking on the matter.” We will see what the future holds
Inflation
The pre-Iran PPI inflation report for February was troubling. The core (goods and services excluding food and energy) reading year over year was 3.9%, above expectations of 3.7% and higher than January’s revised reading of 3.5%. If the drivers of this report bleed into the PCE report (the Fed’s favorite inflation measure) it will not bode well for future inflation as energy disruption comes into play.
CHANGES IN RATES
TreasuryMarket
Treasury yields continued to move higher throughout the week. The Treasury yield curve flattened a bit with short-term rates moving marginally higher than long-term rates.
Treasury bonds currently give investors positive real yields. For example, a 10-year Treasury gives an investor a real yield of 1.29% versus a long-term average of 1.86% (Z-score of -0.33). A 5-year Treasury bond generates a real yield of 0.91% versus a long-term average of 1.38% (Z-score of -0.263). An investor earns 91% of the 10-year Treasury bond income with a 5-year Treasury security for only about 55% of the duration risk. These calculations are based on Fridays closing market for Treasurys and the last core PCE inflation reading of 3.10%. Inflation reading may go higher followed by Treasury yields, but on a relative value basis this is not a bad entry point, well above the long-term average of 77%.
The spread between 2-year and 10-year Treasury securities ended last week at 0.56% and ended this week at 0.51%, no doubt reacting to the Fed’s interest rate decision and the presser that followed.
The market has significantly repriced and lowered the probability of a Fed rate cut in 2026. In fact, the market has assigned a positive probability (albeit small) of a Fed increase in short-term interest rates at the April and June meetings. Jerome Powell’s term as chairman ends in May, but he may stick around (see above).
Municipal Market
The muni market followed the Treasury market in yield rally. The 2/10 spread for last week was at 66 basis points, 15 basis points higher than the week before.
Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio
Municipal bonds look well bid when compared to their taxable equivalents. Shorter maturity AA General Obligation Bonds (maturities inside of 5 years) look rich compared to long-term average and taxable breakeven rates. Before reacting, investors must account for potential capital gain considerations and the fact that these ratios are volatile and can change with new issue supply, currently targeted at $10+ billion for this week (a relatively heavy week).
Within the municipal market, 5-year AAA general obligation bonds are relatively attractive when compared to 10-year AAA general obligation bonds. The yield ratio is 83.1% versus a long-term average of 67.6%. for only approximately 55% of the duration risk.
Investment Grade Corporates
Investment-grade corporate bond yields increased materially.
We’ve covered a lot of Washington in the opening of this week’s review. But we should also cover the future U.S. deficit and debt picture.
“The Pentagon has asked the White House to approve a more than $200 billion request to Congress to fund the war in Iran, according to a senior administration official, in an enormous new ask that is almost certain to run into resistance from lawmakers opposed to the conflict.” Cost of Incursion
It seems to us that this request is another breadcrumb highlighting the risk of mission creep. This is in addition to the cost of the tariff refunds ($175 billion and counting).
“The federal government is estimated to owe American businesses up to $175 billion in tariff refunds after the Supreme Court struck down much of the Trump administration's import duties last month. But the U.S. could end up owing considerably more money, according to a new analysis — in interest payments.” Profligate
These budget busters will lead to increased debt issuance coupled with increased inflation pressures. Oh, MY!
The partial government shutdown is still underway. Most affected Americans are those flying:
“Regardless of politics or destination, American air travelers were unified by one desire Saturday: It’s time to pay Transportation Security Administration employees.
“‘Everybody got bills they have to pay, and it’s horrible,’ said Patrice Clark, whose trip to Las Vegas began Saturday with a nearly four-hour wait in a security line at Dallas Fort Worth International Airport. ‘Times are hard for everybody at this point. Working and not getting paid and gas prices are extremely high — like everybody needs their money. They need to pay them.’” Not So Friendly Skies
Here is a thought: how about when Congress causes a government shutdown of any size or duration, they and their staffs go without pay. Staffs calling in sick would certainly shorten the duration of these shutdowns (since we all know the congressional staffs are the ones that do all the work).
The 5-year Breakeven Inflation Rate finished the week of March 20 at 2.13%, 2 basis points higher than last week. The graph above contrasts a 5-year breakeven inflation rate tracked weekly. This is the market implied inflation rate. We track this relative to core PCE, the Fed’s favorite inflation measure. The 10-year Breakeven Inflation Rate finished the period at 2.38%, 2 basis points higher than last week.
Last week's 10-year quality credit spread between BBB revenue bonds and AAA general obligation bonds was 0.84%, higher by 3 basis point for the week. The historical average credit spread is at 1.68%.
Investment grade spreads for the past week were at 109 basis points, 5 basis points lower than the previous week. The long-term average for investment grade is 1.56%. High-yield credit spreads are 3.11% for the week ending March 20. This is 64 basis points wider than the reading at the end of 2025, no doubt feeling the issues in the private credit markets.
Money Market Flows (millions of dollars)
Money market fund flows were positive on the whole last week. Not surprising, given recent market volatility.
Mutual Fund Flows (millions of dollars)
Mutual fund flows were mixed last week.
ETF Fund Flows (millions of dollars)
Net ETF flows were negative except for municipal.
This is another big municipal new-issuance week with more than $13 billion in tax-exempt calendar issuance.
It has been quite a week. The Treasury curve has flattened, and the municipal bond curve has steepened — not as strange an occurrence as it may sound. All our SMAs are strategically positioned in the neutral duration range. Our overweight to the short end of the yield curve in our respective SMAs, has added performance in the municipal market accounts and has subtracted performance in our taxable accounts, in the short term. But even with this varied experience the activity-managed ladder structure shows its versatility. All our accounts will have 7.5% – 15% of their assets maturing in one year and can then redeploy these assets in the most attractive positions on the yield curve. We continue to focus on higher credit quality securities because we do not feel we are being paid to take credit risk. That may change and we are ready to take advantage of that change.
We realize that markets like these can be distressing. It is in markets like these that a laddered portfolio structure works best. Securities mature each year and can be reinvested in an optimal fashion. This is a key strength for a long-term investor interested in long-term results.
It is also in markets like these where a financial advisor shows their value, coaching clients and calming their fears. Like most bear or near-bear markets, this too shall pass — but a laddered portfolio gives investors the best chance to profit from these events.
And though we have focused mostly on the economic impact of the Iran war, we certainly have not forgotten the human impact.
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