WEEK ENDING 1/10/2025
- Strong jobs numbers dampen view of Fed Rate cuts.
- Fiscal and tariff uncertainty cause market sell-off.
- Damage and loss of life in LA County climb.
- Register for our fixed-income market outlook on Thursday.
A CITY DIFFERENT TAKE
Happy New Year from the fixed-income team. We have entered 2025 with uncertainty about both fiscal and tariff policies.
Friday saw strong jobs numbers for December. Actual nonfarm payroll growth of 256,000 for December surpassed earlier estimates of 165,000 jobs. Average hourly earnings stood true to consensus at a 0.3% increase month-over-month. Finally, the unemployment rate dropped from 4.23% to 4.08%.
Bond rates rallied in reaction to strong job numbers. The 10-year Treasury ended the week at 4.76%, and the 30-year ended at 4.94%. Employment was an important metric for a market that is looking for some certainty this year in monetary policy.
The Federal Reserve’s mandate requires full employment. Last year’s rate cuts were preceded by unemployment touching 4%. The job number reassures the Fed and the market that the economy is still healthy. The bear steepener was the market reaction to an increase in the probability of a rate pause from the rate-cutting cycle.
Wall Street reacted promptly by paring down any rate cut forecast. Notable amongst them is Bank of America, which no longer expects a rate cut this year. Goldman Sachs has an expectation of two rate cuts this year, one in June and the other in September. They are forecasting a terminal rate between 3.5% and 3.75%. JP Morgan expects a rate cut in June and a final cut in September with a terminal rate of 4%. The bottom line here is that the market is coming to grips with the fact that the terminal rate will remain higher for longer.
The other important factor to consider has been inflation. Inflation has been status quo, with the last release of the CPI YoY Index at 2.7%. The next release is this Wednesday, with expectations on the higher side at 2.9%.
Last week, the Washington Post kicked off a story about the incoming administration’s plan to apply tariffs universally to every country. However, it would be limited to certain industries. President-elect Trump claimed the story to be an example of fake news. Markets will need clarity on tariffs, a key policy feature.
We turn our attention now to the devastating fires across Los Angeles. Damage estimates by AccuWeather are near $250 billion, making it one of the worst fires in U.S. history.
While some progress is being made in containing the fires, the weather forecast for Tuesday calls for gusty Santa Ana winds. The Los Angeles municipal water system that provides water for the city does not have enough water for hydrants to support the firefighting efforts. The other element of this story is the shrinking California insurance market.
Insurers, in general, have been pulling back from areas prone to natural disasters. Data from the Wall Street Journal quotes State Farm Insurance refusing to renew policies for 30,000 homeowners in California. The state offers a plan of last resort, capping damages at $3 million. FEMA caps housing assistance at $43,600 a person or household. As President-elect Trump assumes office, it is notable that the FEMA chief’s term is up for reappointment.
CHANGES IN RATES
The Treasury market is reacting to the uncertainty that the year has opened with. We saw the Treasury rally throughout all tenors.
The year started with a big bear steepener for the muni yield curve, with the long end rising at a faster rate than the short-term part of the curve.
The muni-Treasury ratio reflected the rally in rates for both asset classes and widened a bit to show munis rally outpacing in the longer tenors.
Corporate yield reflected the Treasury curve in the bear steepening.
THIS WEEK IN WASHINGTON
All eyes, especially those of the municipal community, are on the expiring $10,000 SALT write-off. President Biden’s Inflation Reduction Act had unsuccessfully proposed eliminating or raising the SALT deduction limit. President-elect Trump expressed he is willing to engage in a solution. There are some 22 odd states that have enacted workarounds that allow some state and local taxes to be deducted beyond the SALT cap.
The SALT cap is more painful for high-tax states like New York and California. To this effect, House Republicans from New York, California, and New Jersey (along with 16 other Republicans) visited with the president-elect at Mar-a-Lago to “raise or eliminate” the SALT cap. It’s noteworthy that Trump will need all Republican members of the House to vote for any tax bill. Rumors are that his advisors have already agreed to a cap increase to $20,000.
The Washington Post tariff article alerted the market that tariff policies could reach far beyond just targeting China. Canada is sharpening its pencil with Prime Minister Justin Trudeau saying that his government is ready to retaliate if the U.S. places tariffs on Canadian products.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of January 10 at 2.35%, 7 basis points higher than the beginning of the year. The 10-year Breakeven Inflation Rate finished the week at 2.43%, 9 basis points lower than January 2.
MUNICIPAL CREDIT
As of January 10, 10-year quality spreads (AAA vs. BBB) were 0.88%, 2 basis points tighter than the beginning of the year (based on our calculations). The long-term average is 1.70%.
Quality spreads in the taxable market are not attractive. They ended the week at 0.64%, 3 basis points tighter than the beginning of the year. High-yield quality spreads were 1 basis point wider at 2.63% week-over-week. These spreads have been grinding tighter from their all-time tights.
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Overall, money market funds saw increased inflows, starting 2025 in the green.
Mutual Fund Flows (millions of dollars)
Cash flows into bond funds were down in all categories.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced increased flows.
SUPPLY OF NEW ISSUE MUNICIPAL BONDS
The supply of new issues is expected to be around $16 billion, and the annual average is closer to $11 billion. Remember, in the last month, municipal yields have risen anywhere between 25 and 40 basis points.
CONCLUSION
The yield moves in the fixed-income markets are cementing a bear steepener. We have entered the year with an unusual amount of fiscal volatility, compounded by tariff uncertainty and a change in administration.
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