Markets Hate Uncertainty

WEEK ENDING 2/28/2025

• Markets hate uncertainty.
• Why buy bonds?
• Consumer sentiment drops.

A CITY DIFFERENT TAKE

Markets hate uncertainty, and this past week was loaded with it.

On the economic front, the week of mixed news started with data on new home sales. Month-over-month new home sales dropped -10.5% for January (compared to expectations of -2.6%). December’s reading was revised up significantly from +3.6% to +8.1%. The reasons given for January’s decline range from colder weather to higher mortgage rates, and we suspect a little “pull forward” from December’s revised sales.

The Q4 quarter-over-quarter GDP release was right on the screws — 2.3% compared to estimates of 2.3% with no prior revisions. The Atlanta Fed’s GDPNow growth model estimate for Q1 GDP has declined to -1.5%.

Next up was Thursday’s initial jobless claims release of 242,000 (compared to estimates of 221,000, with minor prior revisions).

Friday’s release of the Personal Consumption Expenditures (PCE) price index — the Fed’s favorite inflation measure — was the one most anticipated by the markets. Again, the year-over-year numbers were right on the screws of +2.5% with no prior revisions. The core numbers were similar, with estimates of +2.6% and an actual read of +2.6%. Inflation is proving sticky.

All this and recent events in Washington (see later in commentary) feed into what can best be described by Barron’s article, “Consumers Are Worried About the Economy. What’s Behind the Consumer Sentiment Drop.”

“The University of Michigan’s consumer sentiment index surprised to the downside in February, coming in at 64.7. Economists were expecting the index to tick down to 67.5 from the preliminary reading of 67.8, according to FactSet.

The latest sentiment reading, reported Friday, reflected a substantial drop from December’s reading of 74, and January’s reading of 71.1. It followed Walmart’s issuance Thursday of disappointing financial guidance for the fiscal year ending in January 2026. Both reports rattled investors, and helped to send the S&P 500 down more than 100 points, or 1.7%, in Friday’s trading.”

We have been asked by multiple clients, “Why buy bonds?” We are putting together a blog piece explaining our outlook on bonds and the reasons for their inclusion in a client’s portfolio. We will endeavor to give our readers the “Readers Digest” version (if anyone remembers that publication) below. First, the ground rules:             

• All bonds are not created equal.
• Yield is not always a good measure of total return.
• We will use our limited taxable and municipal SMA strategies as illustrations. The short-term SMA strategies will magnify these conclusions, and the intermediate-term municipal SMA strategy will reduce the impact of these results.
• Our strategy is to overweight the 1–5-year segment (+15% per maturity) of the limited-term SMA investment universes and underweight the 6–10-year segment (+5.0% per maturity) of those SMA investment universes.
• All allocations are within a laddered portfolio structure.
• Quality spreads remain very narrow, so investors are not getting paid to take credit risk.

CHANGES IN RATES

Yields came down in all tenors of Treasury securities, and the slope steepened to 25 basis points. The S&P 500 index was down 58.6 points week-over-week, so yields no doubt reacted to the volatility in the equity markets.

Reasons to include Treasury bonds in a client’s portfolio:                 

1. Taxable bonds vs. money market funds. A well-respected national money market fund (VMFXX) saw its yield decline 1.03% from Feb. 26, 2024, (5.28%) to Feb. 26, 2025 (4.25%). Its total return for the same period was 5.03%, net of fees. Our Bloomberg US Gov/Credit benchmark saw its yield decline from 4.80% to 4.36% (-0.44%) over the same period. Its total return was 5.80%. As of Feb. 26, the relative yields are competitive (even accounting for 0.25% of fees).
2. Taxable bonds have a much lower correlation to the equity markets providing diversification. We ran correlation analysis of our 1–10-year Bloomberg US Gov/Credit benchmark versus the S&P 500 (yes, we are aware of the selection bias of the S&P 500 index). As we calculated, the 90-day average correlation going back to June 6, 2008, based on weekly observations was 0.074. (90-day correlation on Feb. 21 was -0.011.)
3. Based on January core PCE, the 1–5-year segment of the Treasury market has the best relative real yield.
4. The Treasury yield curve is very flat, so investors are not getting paid to accept more duration risk.
5. Five-year Treasury bonds are a better value than 10-year Treasury bonds relative to their duration (96% of the income vs. 50% of the duration).

Interest rates in the municipal market mimicked Treasuries to a lesser extent.

Reasons to include municipal bonds in a client’s portfolio: 

1. Municipal bonds have a much lower correlation to the equity markets, providing diversification. We ran a correlation analysis of our 1–10-year Bloomberg Muni 1–10-year Total Return benchmark versus the S&P 500 (see our note above about S&P 500 selection bias). As we calculated, the 90-day average correlation going back to June 6, 2008, based on weekly observations, was 0.047 (the 90-day correlation on Feb. 21 was -0.004)
2. Based on January core PCE, the 1–5-year segment of the municipal market has the best relative real yield.
3. The Treasury yield curve is very flat, so investors are not getting paid to accept more duration risk.
4. Five-year Treasury bonds are a better value than 10-year Treasury bonds relative to their duration (92% of the income vs. 55% of the duration).

The muni-Treasury ratio was range-bound week-over-week.

Corporate yields were also lower on the week.

THIS WEEK IN WASHINGTON

Speaking of uncertainty, the public mugging of the president of Ukraine by the president and vice president of the United States in the Oval Office did not help matters much.

That was the proverbial cherry on top of this week’s sundae — we will leave it to your imagination as to what kind of sundae it is — that included the United States voting along with Russia, China, and North Korea against a UN resolution condemning Russia’s war against Ukraine. As descendants of the Greatest Generation, have we forgotten what our parents and grandparents fought for? This brings to mind the Bernard Lewis quote, “America is harmless as an enemy but treacherous as a friend.”

On a more practical side, what happens if our “friends and allies” on the international stage lose confidence in the United States and our Treasury bond market? The following table illustrates a sampling of the countries that own the most U.S. debt. (Note: Russia did not make the list.)

The total amount of debt of the United States as of Dec. 31, 2024 is $35.46 trillion. The question that jumps to our minds is: can a debtor nation afford to alienate its allies and creditors, especially if they are one and the same? Ex-China, foreign countries own 17.7% of our debt. If we continue treating our allies poorly (tariffs, etc.), why would they continue to buy our debt? We realize that some may say it is in their best interest because of what they own. At some point, they may look at their future interests and decide the losses on legacy assets are worth it.

Other headlines of the week:

“Many analysts say the impact of the uncertainty surrounding their imposition has already taken a toll on the markets and the economy.

“President Donald Trump said Thursday that 25% tariffs on goods imported from Canada and Mexico would go into effect Tuesday, alongside yet another 10% layer of duties on China following one that came into effect earlier this month.” My favorite Word is Tariff

“The House GOP budget plan instructs committees to craft legislation that would cut $4.5 trillion in taxes and at least $1.5 trillion in spending while raising the debt ceiling by $4 trillion. If House committees don't achieve at least $2 trillion in spending cuts, then tax cuts would be scaled back, according to an amendment to the resolution that was added to appease conservatives.” Lite on Details

3. “DOGE Quietly Deletes the 5 Biggest Spending Cuts It Celebrated Last Week”

The cuts, highlighted on an earlier version of the “wall of receipts” posted by Elon Musk’s team, contained mistakes that vastly inflated the amount of money saved.

These were the original five largest savings on its list:

• An $8 billion cutat Immigration and Customs Enforcement. The actual contract in question was worth $8 million. The mistake seemed to stem from an earlier, erroneous entry in a federal contracting database. But contracting experts said that the service should have known better: ICE’s entire budget is about $8 billion, making it implausible that one contract could be so large. The U.S. DOGE Service adjusted the figure on the site after The Times wrote about it, and said in a post on Mr. Musk’s X platform that it had “always used the correct $8M in its calculations.”
• Three $655 million cutsat the U.S. Agency for International Development. This was actually a single cut that was erroneously counted three times, as first reported by CBS News. That mistake also seemed to reflect a misunderstanding of the way government contracts work; they sometimes have “ceiling values” far in excess of what will be spent. Experts said this cancellation was unlikely to produce anything close to $655 million in savings even once. Now, the site lists a much smaller savings for these three cancellations: $18 million in total.
• A $232 million cut at the Social Security Administration. Here, Mr. Musk’s organization appeared to have mistakenly believed that the agency had canceled a huge information technology contract with the defense contracting giant Leidos. Instead, as reported by The Intercept, it had canceled only a tiny piece of it: a $560,000 project to let users mark their gender as “X.” The DOGE site now shows that small cut instead.

Some of the new canceled contracts added this week appear to make some of the same types of errors.

The largest savings on the latest version of its list is a $1.9 billion cut at the Treasury Department. But The Times reported last week that this contract was canceled last fall, when Joseph R. Biden Jr. was president — and when DOGE did not yet exist. Doge Math

4. Finally, the scariest. “Trump allies circulate mass deportation plan calling for ‘processing camps’ and a private citizen ‘army’”

“A group of prominent military contractors, including former Blackwater CEO Erik Prince, has pitched the Trump White House on a proposal to carry out mass deportations through a network of ‘processing camps’ on military bases, a private fleet of 100 planes, and a ‘small army’ of private citizens empowered to make arrests.” The Rhyme of History rings Loud or Will their shirts be Brown

Markets hate uncertainty and this week was chock-full of it.

WHAT, ME WORRY ABOUT INFLATION?

The 5-year Breakeven Inflation Rate finished the week of Feb. 28 at 2.18%, 1 basis point higher than Feb. 21. The 10-year Breakeven Inflation Rate finished the week at 2.38%, 4 basis points lower week-over-week.

MUNICIPAL CREDIT

As of Feb. 28, 10-year quality spreads (AAA vs. BBB) were 0.84%, 3 basis points tighter 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 0.87%, 7 basis points wider than the prior week. High-yield quality spreads were 12 basis points wider at 2.72% week-over-week.

WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?

Money Market Flows (millions of dollars)

Overall, money market funds saw increases in inflow across the board.

Mutual Fund Flows (millions of dollars)

Cash flows into bond funds were up week-over-week across most categories.

ETF Fund Flows (millions of dollars)

ETF asset classes experienced an increase in net flows.

SUPPLY OF NEW ISSUE BONDS

The supply of new issues is expected to be closer to $10.4 billion this coming week, compared to the weekly average of approximately $11 billion.

CONCLUSION

We are maintaining our neutral duration stance but are keeping the words of Jim Morrison in mind:

“The future is uncertain, and the end is always near.”

IMPORTANT DISCLOSURES
The information and statistics contained in this report have been obtained from sources we believe to be reliable but cannot be guaranteed. Any projections, market outlooks or estimates presented herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product or any non-investment related content, made reference to directly or indirectly herein will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.

All indexes are unmanaged, and you cannot invest directly in an index. Index returns do not include fees or expenses. Actual portfolio returns may vary due to the timing of portfolio inception and/or investor-imposed restrictions or guidelines. Actual investor portfolio returns would be reduced by any applicable investment advisory fees and other expenses incurred in the management of an advisory account.

You should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from City Different Investments. To the extent that a reader has any questions regarding the applicability above to his/her individual situation or any specific issue discussed, he/she is encouraged to consult with the professional advisor of his/her choosing. City Different Investments is neither a law firm nor a certified public accounting firm and no portion of this content should be construed as legal or accounting advice.

A copy of City Different Investments' current written disclosure statement discussing our advisory services and fees is available for review upon request.

Unless otherwise noted, City Different Investments is the source of information presented herein.

A description of the indices mentioned herein are available upon request.