WEEK ENDING 1/31/2025
- Two horrific plane crashes claimed 73 lives. Investigations into causes are underway.
- DeepSeek is not an AI hallucination… we think.
- Purges of FBI, Department of Justice, and Inspectors General are underway.
- Is this the week of “The Peter Principal”?
- Tariffs on our three largest trading partners effective Tuesday.
A CITY DIFFERENT TAKE
On Monday, the markets awoke to the introduction of DeepSeek, a Chinese startup with a reportedly cheaper open source, large language AI model, equal to or better than US competitors like ChatGPT:
“BEIJING, Jan 27 (Reuters) - Chinese startup DeepSeek's launch of its latest AI models, which it says are on a par or better than industry-leading models in the United States at a fraction of the cost, is threatening to upset the technology world order.”
This announcement sent equity markets reeling. The S&P 500 was down 88.96 points (or -1.46%) into Monday’s close. The index did recover slightly by Friday, +0.46% from the previous Friday’s close. Pretty much a “dead cat bounce.” The ten-year Treasury security declined in yield by 8.7 basis points. It finished the week 8 basis points lower than last Friday’s close.
The one thing that we have been discussing: when did the Chinese or Chinese companies become so altruistic? If you are afraid of TikTok from a national security standpoint, shouldn’t you be petrified of this? Being bond folks, our optimism is often on hold.
Also on Monday, the current administration proposed freezing spending on federal loans and grants. By Wednesday, the order was rescinded:
“WASHINGTON (AP) — President Donald Trump’s budget office on Wednesday rescinded a memo freezing spending on federal loans and grants, less than two days after it sparked widespread confusion and legal challenges across the country.
“The memo, which was issued Monday by the Office of Management and Budget, had frightened states, schools and organizations that rely on trillions of dollars from Washington.”
Yes, the Federal Reserve Board held its first meeting of 2025 on Jan. 29 and decided to keep the Federal Funds rate unchanged (much to the president's chagrin).
“‘Because Jay Powell and the Fed failed to stop the problem they created with Inflation, I will do it by unleashing American Energy production, slashing Regulation, rebalancing International Trade, and reigniting American Manufacturing,’ he wrote on his Truth Social platform, referring to Federal Reserve Chair Jerome Powell.
“‘If the Fed had spent less time on DEI, gender ideology, “green” energy, and fake climate change, Inflation would never have been a problem,’ he said.”
The DEI comments sound like a new Judas goat in the making. This theme will be revisited later.
Chair Powell’s take on the decision was a little different:
“Powell said at a news conference after the announcement that recent inflation data looked ‘good’ but that ‘we’re not going to over-interpret two good or two bad (inflation) readings.’
One would have thought that this announcement would be a major driver of market volatility, but rates barely moved. That’s maybe because the market had anticipated this or that the announcement didn’t even crack the top three market moving factors.
The Fed’s favorite inflation measure was released Friday morning, again not the day’s biggest announcement. The Core U.S. Personal Consumption Expenditure Price Index came in at 2.8%, the third month in a row the reading was at a level above the Fed’s target of 2.0%. But this paled by comparison to the administration’s tariff comments:
“Trump spoke extensively about the tariffs on Friday, acknowledging they could lead to disruptions and hardships for Americans. He said additional tariffs were planned against steel, aluminum, semiconductor chips and pharmaceuticals.”
This was followed on Saturday by the announcement of tariffs on our three major trading partners: 25% on goods from Mexico; 25% on goods from Canada, including 10% on Canada’s energy; 10% on goods from China. Announced tariffs are effective Tuesday:
“U.S. President Donald Trump on Saturday ordered sweeping tariffs on goods from Mexico, Canada and China, demanding they stanch the flow of fentanyl - and illegal immigrants in the case of Canada and Mexico - into the United States, kicking off a trade war that could dent global growth and reignite inflation.”
We have made this reference before, but does anyone remember reading about the Smoot-Hawley Tariff Act of 1930?
“President Donald Trump has tweeted that ‘trade wars are good and easy to win.’ But many economists have disagreed that raising tariffs sharply can improve the economy. In particular, experts have pointed to the failure of the Smoot-Hawley Tariff Act, passed in June 1930, to protect U.S. industries from tariff increases.
“Although this came several months after the stock market crash of 1929, the U.S. hadn’t yet entered ‘the full onset of the Great Depression,’ says Claude Barfield, a resident scholar at the American Enterprise Institute. The thinking among Congress and President Herbert Hoover was that by raising taxes on thousands of imports no matter what country they came from, the act would protect American farmers and secure the nation’s economy. But experts disagreed.”
By the time you read this, you’ll probably know how the markets opened on Monday.
This week, we can look forward to the JOLTs report and Friday’s employment report.
CHANGES IN RATES
Rates in the Treasury market were lower this week. Most of the move came Monday after the DeepSeek release. The yield curve steepened marginally, as measured by the 2/10-year Treasury slope, moving to +0.36 from +0.34 last week.
Interest rates in the municipal market also declined last week, albeit marginally.
The muni-Treasury ratio tightened even further, making munis slightly richer.
Corporate yields trended lower over the week.
THIS WEEK IN WASHINGTON
Here’s more from the Washington this week, and what a week it was:
- On Monday, the Office of Management and Budget (OMB) issued an order “calling for a temporary pause” to more than $3 trillion of federal spending. Chaos ensued. The day after, a federal judge blocked the directive. The Trump administration rescinded the order soon thereafter.
- Secretary of Homeland Security Kristi Noem, dressed in tactical gear and followed by cameras, hit the streets of New York in an “enforcement operation” — and it’s not even Halloween.
- The purge continues at the FBI and Justice Department:
“WASHINGTON — Several top FBI executives promoted by former Director Christopher Wray were told Thursday to resign or retire or they would be fired, according to multiple current and former bureau officials.
Trump fired 18 inspectors general last week, including watchdogs for the State, Defense and Labor departments and the Department of Health and Human Services.
The Trump administration has also fired career attorneys at the Justice Department who were involved in prosecuting him, raising alarms over his making good on threats of retribution against those who have challenged his conduct.
- Within 24 hours of the horrific air collision outside Reagan Airport, the president made a statement about the cause of the accident. (It will take months for the NTSB to issue a preliminary report).
“Trump first claimed, without evidence, that diversity, equity, and inclusion initiatives under Democratic presidents could be a factor. He later doubled down on the unsubstantiated claim while he signed executive orders in the Oval Office.”
Research into the issue yielded more:
“Trump pointed to a New York Post article as he accused Democrats of pushing to hire people with severe mental disabilities at the Federal Aviation Administration. But the diversity language referenced in the article was on the FAA website during the entirety of Trump’s first term and has been on the site for more than a decade, according to Snopes.”
- Finally, tariffs roiled quiet markets after a much anticipated inflation report:
“The news sent the Dow Jones Industrial Average down more than 300 points, or about 0.7%. The S&P 500 and Nasdaq Composite both turned in losses as well. All three major benchmarks were up solidly earlier in the day.
“Karoline Leavitt, the White House press secretary, said Trump will be implementing 25% tariffs on Mexico and Canada as well as a 10% duty on China, in retaliation for ‘the illegal fentanyl that they have sourced and allowed to distribute into our country.’” End of a perfect week
FiveThirtyEight shows the average of a number of polls regarding the president’s approval rating. The President’s disapproval rating as of Jan. 31 1/31/2025 has increased to 43.9%, up from 41.5% on 1/25/2025 Jan. 25.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of Jan. 31 at 2.30%, 4 basis points lower than Jan. 24. The 10-year Breakeven Inflation Rate finished the week at 2.42%, 1 basis point higher than Jan. 24.
MUNICIPAL CREDIT
As of Jan. 31, 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 0.82%, 1 basis point tighter than the prior week. High-yield quality spreads were 1 basis point wider at 2.51% week-over-week.
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Overall, money market funds saw a decrease in inflows compared to the prior week.
Mutual Fund Flows (millions of dollars)
Cash flows into bond funds were positive week-over-week across most 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 $6.5 billion this coming week. The annual average is approximately $11 billion.
CONCLUSION
The news can be worrying. If investors focus of every individual tweet they will develop investment whiplash. We will continue to focus on the value measures that have served us well over the years. We will also try to look for some good news in all this chaos. And there’s always sports. For example, the Super Bowl is only a week away. (Fly, Eagles, fly.) And the Six Nations rugby tournament started this weekend with France and Ireland looking formidable.
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