● The economy slows down
● Soft data for the labor market
● Blame tariffs and restrictive labor policy
Last week was an important week for data releases. The Federal Reserve left policy rates unchanged at 4.25%–4.50%. The market priced chances of a rate cut for September at less than 45%, following the Fed's hawkish tone to keep rates higher for longer. But drumroll, please — by Friday, weak jobs data quickly overshadowed the Fed.
Hiring slowed in the last three months. May and June numbers were revised lower by a whopping 258,000. The July jobs report also showed soft hiring data. Over the previous three months, job growth has slowed to an average of 35,000. The unemployment rate now stands at 4.2%.
The bond market reacted strongly to this, with 2-year Treasury rates dropping by nearly 25 basis points and 10-year Treasury rates declining by 16 basis points. The bond market has surged after the warning sign from the labor market, and Fed rate cut bets for September are now at 90%.
Real GDP for Q2 came in at 3% after falling to 0.5% in Q1. We are in uncharted territory trying to estimate the impact of tariffs on consumers and corporations.
To quickly recap the Fed’s meeting, the fed funds range remained unchanged while the governors issued the first double-dissent since 1992. Governors Miki Bowman and Chris Waller dissented in favor of a quarter-point cut.
The description of economic activity was revised from “continued to expand at a solid pace" to "moderated in the first half of the year.”
In its July meeting, the Fed said it was waiting for the two jobs reports and the two inflation reports to determine the outcome of September’s rate decision. Inflation has been mild, and job numbers have been weaker than expected. The Fed still sees one more set of prints before its next meeting.
The GDP report also came out last week. The economy grew by 3% in the second quarter after falling 0.5% in the first quarter. Slow growth has been attributed to a slowdown in government spending. There is a lot of uncertainty with tariffs, and this volatility in trade has caused big swings in GDP growth for the first half. Consumers and corporations have front-loaded inventories and purchases.
Between the slowing of economic activity and the slowdown in the labor market, the case for a rate cut is getting stronger.
Core PCE inflation was 2.8% in June. Tariffs have not caused much of an inflation uptick for now. Core PCE prices grew by 0.3% for June.
CHANGES IN RATES
The bond market rallied. 2-year yields dropped by 25 basis points week over week. The 2/10 curve steepened to 53 basis points.
Yields in the municipal market were lower throughout the curve. This week, the 2/10 spread in the muni market was 87 basis points.
Treasury-muni ratios got cheaper in the front end and moved marginally in the 10/30-year tenor.
Investment grade corporate bond yields moved lower week over week.
The Wall Street Journal reported that the Trump Administration is struggling in the appeals court hearing against the lower court trade ruling against tariffs. Under the Constitution, tariffs fall within the purview of Congress. Accordingly, the White House can only set terms if Congress delegates those powers. A precedent was set in 1973, when President Nixon had emergency power to impose tariff rates. However, the power was delegated by Congress.
After weak job numbers, President Trump fired the commissioner of the Bureau of Labor Statistics. This bears an ominous shadow on monetary policy and mirrors the politicization of the Fed. Critics have pushed back on this decision, as it could undermine confidence in official U.S. economic data.
In new trade deal news, there will now be a 15% tariff on South Korea and a 25% tariff on India. Other countries that have negotiated trade deals are Thailand, Cambodia, Taiwan, and Pakistan. As of now, the U.S. does not have a deal with either Canada or Mexico.
The stock market reacted strongly to the labor and tariff news by posting its worst day since May. Have we mentioned volatility as the theme in 2025?
The 5-year Breakeven Inflation Rate finished the week of August 1 at 2.28%, 13 basis points lower than the previous period. The 10-year breakeven inflation rate finished the period at 2.33%, 11 basis points lower than the observation on July 25.
As of August 1, the 10-year quality spreads (AAA vs. BBB) were at 0.89% (based on our calculations). The long-term average is 1.69%.
Investment grade spreads are extremely tight at 0.78% due to lower supply in July. The high yield spread is lower at 2.95%.
Money Market Flows (millions of dollars)
Overall, money market fund flows were higher week over week.
Mutual Fund Flows (millions of dollars)
All asset classes experienced inflows last week.
ETF Fund Flows (millions of dollars)
ETF asset classes saw a net outflows over the week.
Muni issuance for July hit $60 billion. Tax-exempt muni issuance YTD has been $82 billion. This week’s supply is expected to be close to $17 billion, which is a big number.
Labor markets are showing signs of slowing down. June's inflation showed a slight uptick. The second quarter's GDP showed wild swings in a year of unpredictable policies. The markets are pricing a rate cut in September. However, the Fed has one more set of jobs and inflation data before that meeting.
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