WEEK ENDING 1/17/2025
- CPI report dilutes jobs report, for now
- A new administration began Monday
- Prepare for volatility
A CITY DIFFERENT TAKE
Last week’s CPI report took some of the sting out of the carnage from the previous jobs report. The data, however, did not seem that convincing. Month-over-month CPI came in at 0.4%, higher than last month’s 0.3%. Core month-over-month CPI was 0.2%, falling below expectations of 0.3% and last month’s 0.3%. Year-over-year core CPI was 3.2%, below expectations of 3.3%, and last month’s reading of 3.3%.
The market still awaits the PCE report at the end of the month. We do expect higher volatility going forward. Reacting to the last data point could prove problematic. We will continue to rely on our value metrics in construction and managing our client accounts.
CHANGES IN RATES
Rates in the Treasury market decreased last week by varying amounts depending on the tenor in reaction to a slightly better CPI report. The yield curve flattened modestly, moving from a 2/10-year yield spread of +0.37% to +0.34%.
Interest rates in the municipal market also declined last week but at a slower speed. This could be in anticipation of the building of new issues in municipal supply as issuers try to hedge market volatility.
The muni-Treasury ratio widened a bit, reflecting the change in rates for both asset classes.
Corporate yields reflected the Treasury curve in the bear steepening.
THIS WEEK IN WASHINGTON
A new administration came to power on Monday. Some of the campaign promises do lead one to worry about the future of inflation. A pro-growth agenda may increase the Treasury supply. If the DOGE has any teeth, expect disruptions and increased volatility.
This week, the House Committee on Ways and Means released a broad list of potential pay-for options for extending the 2017 Tax Cuts and Jobs Act (TCJA). The 50-page document contains a mix of policy repeals and the elimination of many federal tax expenditures, including a full repeal of tax-exempt interest on municipal bonds, Private Activity Bonds (PABs), Build America Bonds (BABs), and “other” non-municipal bonds.
Again, this issue has come up several times in our career. We think this is a low-probability event, but not a no-probability event.
Bloomberg, quoting a GFOA report, put the cost of increased borrowing — to both blue and red states and their citizens — at $824 billion over a decade.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of Jan. 17 at 2.30%, 5 basis points lower than on Jan. 10. The 10-year Breakeven Inflation Rate finished the week at 2.41%, 2 basis points lower than the higher than Jan. 10.
MUNICIPAL CREDIT
As of Jan. 17, 10-year quality spreads (AAA vs. BBB) were 0.88%, unchanged from the prior week (based on our calculations). The long-term average is 1.69%.
Quality spreads in the taxable market are not attractive. They ended the week at 0.84%, 1 basis point tighter than the prior week of Jan. 10. High-yield quality spreads were 10 basis points wider at 2.54% week-over-week.
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Overall, money market funds saw decreased inflows compared to the week prior.
Mutual Fund Flows (millions of dollars)
Cash flows into bond funds were up week-over-week in all categories.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced positive net flows.
SUPPLY OF NEW ISSUE MUNICIPAL BONDS
The supply of new issues is expected to be closer to $9.4 billion. The annual average is approximately $11 billion.
CONCLUSION
Investors should prepare for volatility. Although inflation looks to have taken a respite with the latest CPI report, it may be resting. Fixed income yield did recover somewhat for the surprise employment report. The economy looks stable to strong. Returning from a road trip from Santa Fe to Los Angeles, Chris noted some anecdotal evidence of a strong economy:
- Thanks to the Infrastructure Bill, the repair work on I-40 was significant. This is only one example, but if it is representative of what is happening across the country, the bill could have long-term effects.
- There was a good deal of truck traffic on the route.
- This route parallels major rail lines, with many large freight trains loaded with double-stacked containers.
This may mean nothing, but often, this type of anecdotal evidence can correlate with overall economic activity.
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