The closure of the Strait of Hormuz is the most consequential macro development for the financial markets in years, and they are still working through the implications.
Headline inflation is tracking above 4%, GDP growth is being revised toward 2.7%, and the Fed is on hold for the foreseeable future. What gets lost in the noise is that the structural position of the U.S. economy in an energy shock is fundamentally different from prior episodes. Domestic production is at an all-time high of 13.6 million barrels a day, and the income generated by the oil and gas sector offsets, at least partially, the consumer spending hit from $4-plus gasoline. WTI is trading at a $12 discount to Brent against a spread that was $1 to $2 before the conflict. That gap is the clearest single data point for understanding who is absorbing the shock and who is not. Europe and Asia, far more dependent on Gulf energy, are facing central bank tightening cycles that carry recession risk. The U.S. is not insulated, but it is in a different category entirely. The fiscal picture adds another dimension worth watching.
The Pentagon's $200 billion supplemental war funding request is pending, with no defined endgame; the tariff refund liability is estimated at $175 billion (and growing with interest); and a partial government shutdown is still underway.
The term premium in the 10- to 20-year Treasury market is not behaving irrationally, it is reflecting a realistic assessment of what unconstrained deficit spending in an inflationary environment looks like.
The Treasury curve and the municipal curve did something different last week, and the divergence is worth understanding. Treasuries bear-flattened — short-end yields moved up more than the long end, with the 2/10 spread compressing to 51 basis points as the market took out rate cut expectations and briefly priced a small probability of a hike at the April and June meetings.
The muni curve did the opposite. The 2/10 muni spread widened to 68 basis points from roughly 46 basis points in February — a steepening move driven by the belly absorbing the heaviest selling pressure. Ten-year high grade muni yields are up 66 basis points month-to-date. The reason for the divergence is structural: the short end of the muni market is anchored by money market and short-duration demand that never left, while the belly absorbed a $14.5 billion new issue calendar concentrated in the 5- to 15-year range. The result is a muni curve that is steeper in shape than the Treasury curve — the opposite of what a casual look at rate moves would suggest. Muni-to-Treasury ratios reflect this. The 30-year ratio moved to 91.5% this week against a long-term average of 97.9%, while the 10-year ratio sits at 70.4% against a long-term average of 89.9%. The long end has moved closer to long-term fair value. The short end has not.
Fed funds futures ended the week pricing roughly 6 basis points of tightening by year-end — a complete reversal from where the month began. The market implied probability of a Fed cut has dropped sharply across every meeting date through December, with the April and June meetings now showing a small but significant probability of an increase. Fedspeak this week reflected the tension without resolving it. Goolsbee acknowledged circumstances where a hike could be warranted but still expects cuts if inflation data improves. Miran still sees four cuts but has revised his year-end rate estimate higher. Barr and Daly characterized the conflict as amplifying risks without offering a clear direction. The through line is that the Fed was already dealing with sticky core PCE above 3% before the conflict began, and the energy shock complicates the picture in both directions — higher headline inflation on one side, weaker growth and labor market risk on the other. In the short-end funding markets, unsecured and secured CP spreads are at or near their widest levels in over a year. Money market fund assets finished the week at $7.8 trillion, with the most recent week showing a modest decline of $53 billion. The April tax date typically pulls $140 to $160 billion out of that complex in a short window, and that seasonal pressure is now approaching against a backdrop of elevated volatility and wider short-end spreads.
CHANGES IN RATES
TreasuryMarket
Treasury yields continued to move throughout the week, landing higher in the belly of the curve. A 51.7-basis-point 2/10 spread is positive but compressed compared to historical norms — the curve is pricing sticky inflation with rate uncertainty. The Treasury curve is pricing a “stagflationary” holding pattern with sticky inflation keeping the front end elevated, deficit spending keeping the belly steep, and structural demand capping the long end. Until the conflict resolves or oil breaks meaningfully lower, the belly stays the most expensive.
Municipal Market
The muni market followed the Treasury market in yield rally. The 2/10 spread for last week was 68 basis points. The move this week was not parallel. Yields rose 16 to 17 basis points in the five-to-nine-year zone and only 10 to 11 points at the long end. The belly of the muni curve bore the heaviest adjustment — consistent with the $14.5 billion new issue calendar landing squarely in the 5- to 15-year range, where most negotiated issuance concentrates.
Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio
Municipal bonds cheapened materially last week as seen by the ratios. We think that there is value in the 20- to 30-year part of the muni curve, approving their long-term fair value.
The key difference from the Treasury curve: munis steepened while Treasuries flattened.
The Treasury 2/10 bear-flattened over the month. The muni 2/10 widened from roughly 46 basis points in February to 68 points today — a steepening move. The reason is structural. The front-end muni market is dominated by money market funds and short-duration demand that never left. That bid kept short muni yields anchored even as longer maturities sold off with Treasuries. The result is a muni curve that is steeper in shape than the Treasury curve — the opposite of what the belly compression in Treasuries would suggest.
Investment Grade Corporates
Investment-grade corporate yields moved higher by 36 to 62 basis points over the month — broadly in line with Treasuries but with a distinct twist. The three-to-five year IG sector moved the most (61 to 62 bps), outpacing the equivalent Treasury move of 53 to 57 bps. That excess is spread-widening — the market is charging more for credit risk in the belly, where earnings uncertainty from oil-driven stagflation is most acute for leveraged borrowers. The long-end IG underperformed less, again because structural buyers are present. Treasuries have safe-haven distortions. Munis have the tax exemption. Investment-grade corporates have neither — they are the cleanest read on what the market actually believes about nominal growth and credit risk.
The week in Washington confirmed two things at once: the executive branch is pursuing a war without congressional oversight, and the legislative branch is struggling to fund itself.
Regarding the war: the Senate voted for the third time to reject a war powers resolution that would have required congressional approval for ongoing military action against Iran. The vote was 53 to 47, nearly identical to the previous two attempts, with Rand Paul the only Republican crossing the aisle. Democrats have repeatedly called for Defense Secretary Pete Hegseth and Secretary of State Marco Rubio to testify in public hearings, but those hearings have not yet happened. The Senate Foreign Relations Committee chairman told Democrats that public oversight hearings would be “counterproductive.” The Pentagon's $200 billion supplemental war funding request remains pending, an open-ended fiscal commitment with no defined endgame and no binding legislative constraints.
On the shutdown: after 42 days, the Senate finally passed a DHS funding measure at 2:20 a.m. on Friday, funding all of the department except ICE and CBP, which Democrats refused to include without immigration enforcement reforms. TSA officers’ call-out rates had exceeded 40% at some airports, with wait times stretching to nearly four hours at major hubs. The measure still needs House approval before TSA employees get paid, but the House has not yet acted.
The fiscal picture these two stories present together is not encouraging for bond investors. An unconstrained war with a shifting cost estimate, a government that periodically cannot pay its own transportation security officers, and a tariff refund liability estimated at $175 billion and growing with interest; these are the factors influencing the term premium calculation in the 10- to 20-year Treasury market. The market is not irrational in demanding higher yields there; it’s being realistic.
The 5-year Breakeven Inflation Rate finished the week of March 27 at 2.06%, 7 basis points lower 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 2.31%, 7 basis points higher than last week.
Last week's 10-year quality credit spread between BBB revenue bonds and AAA general obligation bonds was 0.85%, higher by 1 basis point for the week. The historical average credit spread is at 1.68%.
Investment-grade spreads for the past week were at 111 basis points, 2 basis points higher than the previous week. The long-term average for investment grade is 1.56%. High-yield credit spreads are 3.30% for the week ending March 27. This is 19 basis points wider than the week before. This is riding the fear from the private credit markets.
Money Market Flows (millions of dollars)
Money market fund flows were negative on the whole last week.
Mutual Fund Flows (millions of dollars)
Mutual fund flows were all negative last week.
ETF Fund Flows (millions of dollars)
Net ETF flows were positive through all categories.
After last week’s big calendar and issuance, this week has a small calendar at $6.5 billion this week. Given the volatility, issuers have pulled back on new deals.
It has been a week of the data and the geopolitics pulling in multiple directions simultaneously — and the fixed-income market reflected that tension with unusual clarity. The Treasury curve flattened while the muni curve steepened. The Fed stayed on hold while futures began pricing tightening. Money market assets held broadly stable while CP spreads widened to one-year highs. Credit spreads in both munis and investment grade remain well inside long-term averages: the BBB revenue to AAA GO muni spread at 85 basis points against a historical average of 168 basis points, and investment grade corporates at 109 basis points against a long-term average of 156 basis points. This tells you the credit market has not yet reflected the full range of outcomes the macro picture presents.
However, we are seeing some widening seep into the high-yield market. (Thank you, Private Credit.) The 5-year Breakeven Inflation Rate finished the week at 2.13%, and the 10-year at 2.38%. Those numbers suggest the market still believes the inflation shock is transitory, even as the structural drivers of higher prices — energy, defense spending, tariff refund liability — show no signs of quick resolution. Markets can hold two views at once for longer than they feel comfortable. That is where we are.
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