WEEK ENDING 4/25/2025
- Is a trade deficit a bad thing?
- Confidence in the Fed’s independence.
- The Treasury’s wild ride.
A CITY DIFFERENT TAKE
Is a trade deficit a bad thing? Like most unsatisfying things in life, the answer is not black and white.
What is a trade deficit? A deficit occurs when a country’s imports are greater than its exports. As Americans, we buy more things from outside the U.S. than we sell to the rest of the world. This is neither good nor bad by itself. Let’s look at David Ricardo’s comparative advantage theory. When countries decide to produce one thing over another, what they give up is called “opportunity cost.” It makes sense for countries to produce goods and services that have lower opportunity costs compared to other countries. The goal is to maximize overall output and increase the country's economic welfare through trade.
As of December 2024, the U.S. trade deficit is $1.2 trillion. Economists worry that a trade deficit is an imbalance between domestic savings and total economic investments. However, the U.S. enjoyed a healthy 2.8% real GDP growth in 2024. So, borrowing helps spur the economy's development more than just savings alone. Despite its trade deficit, the U.S. has enjoyed a strong economy and healthy consumers.
The biggest political beef is tied to employment or “U.S. jobs.” A report from the Economic Policy Institute found that the surge in Chinese manufacturing jobs correlated with Chinese imports from 2001 to 2018. This is one reason why we are seeing trade tension between the U.S. and China. As of now, the tariffs on Chinese imports have reached a cumulative rate of 145%.
In last week’s news, Treasury Secretary Scott Bessent encouraged the markets by saying that trade tensions between China and the U.S. could de-escalate soon. We have yet to see any bilateral deals being solidified. However, Japan, Korea, and India are in discussions with the U.S.
Focus has shifted to the role of U.S. Treasuries as a safe-haven asset. Post-Liberation Day, Treasuries have been on a wild ride. Remember that the Treasury Department has pumped $2.3 trillion in new debt annually from 2020 to 2024. In addition, one-third of the U.S. debt is held by foreigners. Market volatility has led to growing recession calls and increased probability of diminished economic growth prospects. Another explanation is the likelihood of tariff-induced inflation. The markets have been swinging between all this uncertainty.
The Treasury market is directly affected by this volatility. It can be seen yo-yoing between yield increases and price increases (remember the inverse dance of the fixed-income asset class).
The term premium — the cost of holding longer bonds — is higher than the cost of holding shorter bonds and has been climbing, as seen by the slope of the curve.
While Treasury volatility has been applied to orderly de-leveraging by hedge funds, we should also try to understand some of the checks and balances that the Federal Reserve maintains:
- The Fed’s standing repo facility guarantees that certain banks and dealers can borrow cash against government bonds.
- The Fed has established swap lines that empower counterparts like the ECB and the Bank of England to lend U.S. dollars.
- Finally, according to the Congressional Budget Office (CBO), the interest cost on national debt is 3.2% of GDP in 2025. While the debt itself might be on a path of unsustainability, the cost of servicing the debt is not by itself unsustainable.
New buyers of Treasury?
Interestingly, the demand for stablecoin is a topic on the table. Chances are high that stablecoin legislation will become law later this year. Even Chair Powell at the Economic Club of Chicago discussed establishing a legal framework for stablecoins.
Earlier last week, the long end of the Treasury curve reacted to President Trump’s displeasure and threats to fire Chair Powell. The threat to the Fed's independence caused a temporary yield rally. However, the week ended with the president assuaging fears of removing the Fed chair, saying that was not his intention.
Section 10 of the Federal Reserve Act says members of the Fed’s Board of Governors, of which the chair is one, can be “removed for cause by the president.” However, “cause” means serious misconduct or abuse of power.
A new test for Treasuries will be later this week when the Treasury releases its latest bond issuance plans.
CHANGES IN RATES
Yield changes in the Treasury market were lower last week. The yield curve in the 1/10-year part of the curve is 0.28%.
Munis remained rangebound in the last two weeks, and yields were marginally higher for this week.
Ratios make muni a little cheaper week over week.
Corporate yields were lower week over week, in line with the Treasury theme.
THIS WEEK IN WASHINGTON
This week marks the 100th day of Trump’s second term. The president has signed 137 executive orders in that time, well ahead of FDR's 99 executive orders over the same timeframe.
The House passed the budget framework resolution earlier this month. Republicans aim to pass the tax package through a process that wouldn’t require any Democratic votes. This means that President Trump, along with House and Senate Republicans, have to pass the package without any disagreements. However, a rift is emerging in the Republican party, threatening to withhold GOP support if the SALT cap (currently limited to $10,000) is not raised. Dissenters include lawmakers from New York, New Jersey, and California. Other dissenters could be Republicans from states that received inflation reduction funding and want to continue some of their green energy tax credits — notably Republicans from Nebraska, Iowa, and Virginia.
Internationally, Russia says it's open to ending the war in Ukraine. However, this did not deter Moscow from launching a large aerial assault against Kyiv last Thursday.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of April 15 at 2.22%, 15 basis points higher than April 11. The 10-year Breakeven Inflation Rate finished the week at 2.34%, 14 basis points higher than two weeks ago.
MUNICIPAL CREDIT
As of April 11, the 10-year quality spreads (AAA vs. BBB) were 1.01%, 8 basis points higher than our last report two weeks ago (based on our calculations). The long-term average is 1.69%.
A reminder to our readers that the year opened with credit spreads grinding around 0.88%. While credits are still very healthy, we are seeing spreads gaping a little. But we are still in the “very tight” category.
TAXABLE CREDIT
Spreads in the corporate and high yield market continue to look unattractive with investment grade spread at 0.84% and high yield at 3.43%
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Overall, all money market funds saw increased inflows.
Mutual Fund Flows (millions of dollars)
Cash flows into bond funds continued to stay negative week over week across all categories.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced some inflow this week.
SUPPLY OF NEW ISSUE BONDS
The supply of new municipal bond issues is expected to be closer to $13+ billion this week. This is following last week’s large calendar of $12 billion. As you saw earlier in fund flows, muni funds had a rough week.
CONCLUSION
While muted last week, tariff uncertainty still lingers this month. We believe in the economy and the taxing power of the United States behind the Treasury market. In addition, the Fed has many tools in its toolkit to support the market if need be. Municipals are seeing a big issuance week.
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