Bonds First Quarter – A Tale of Two Markets and Tariffs

The first quarter of 2025 saw yields on US Treasuries (Tsy) rise at the start of the year with the anticipation of Donald Trump’s inauguration and the expectation for greater spending and for higher potential inflation pushing yields higher in early January. The remainder of the quarter and the first part of April saw Treasury yields come down on the back of weaker economic news and then a large drop in yields in early April on the tariffs that the administration revealed last week.

After the initial rise in yields to start the year, economic numbers supporting a slowing economy began to take hold. This is a partial list: more-tame inflation numbers, higher levels of credit card delinquencies, much lower QUITS rates on jobs, slowing JOLTS numbers (job offerings), various Federal Reserve district manufacturing as well as services indices slowing, a slowdown in both existing as well as new-home sales. Though initial jobless claims were well-behaved, continuing claims have remained stuck to the upside. And now that DOGE layoffs in the Federal government have begun, the market is anticipating those workers being added to the jobless rolls as well as the unemployment rise (which has started).

Muni bond yields were not reacting to economic news as much as to political news. After beginning the year with muted supply (as usually happens), tax-exempt supply began to build towards the latter part of the quarter. But the real thorn for munis was the chatter in Washington about the possible taxation of municipal bonds as a revenue-raising measure. This talk clearly hurt the muni market, and you can see it in the absolute yields but more importantly in the yield ratio numbers in the chart above.

My colleague Ben Pease has laid out the various possibilities being discussed, which include taxation as well as a possible 28% cap on the benefit of federal tax exemption. See “Municipal Bond Tax Exemption,” https://www.cumber.com/market-commentary/municipal-bond-tax-exemption. Our base case is that in the end, Congress will leave the municipal bond alone. Part of that case involves looking at the federal agency reductions and the fact that state and local governments may be picking up activities currently done at the federal level. It would be disingenuous on the part of Congress to tell municipal governments to pick up these bills and then to take away their ability to finance activities at an advantageous rate.

The tariff tornado of this past week sent Treasury yields quickly lower as the carnage in equity markets drove investors to the safety of Treasuries – as usually happens in time of crisis. Munis also picked up the pace – in part because they had become cheap. And with tariffs dominating the headlines and equities sinking, the muni taxation issue has moved to the back burner. However, volatility in markets at the start of this week has propelled both Treasury and muni yields higher. 

Below is a chart showing the change since April 4^th.

The extraordinary change since the end of last week reflects many crosscurrents.  Some of the forces include foreign selling of Treasuries, with potential Chinese selling in retaliation for tariffs; investor unrest, reflected in poor Treasury auctions; and investor selling of Treasuries just to raise cash – period. And a concern that sent yields higher last year with sell-offs was related to fiscal strain in the US. On the muni side, the selling has not been related to tax concerns of munis as much as to the total volatility in the Treasury market, which has made it impossible for municipal dealers to hedge inventory. This has also been reflected in many muni deals being postponed by issuers due to market conditions. And bond fund selling has also resumed – again most likely as a dash for cash, such as Treasuries. Longer bond yields have been beaten up much more than shorter maturities.

Clearly, some stability in the equity markets should bring some leveling from the volatility in the bond markets. Munis are certainly VERY cheap, in our view. The tariff talks will continue to drive bond markets over the near term. But if the economy enters a slowdown (almost certain) or a recession (getting more certain), that trajectory will have implications for municipal credit quality, as an economic slowdown will have effects on income tax levels, sales tax levels, capital gains receipts, and other revenues as well. This means staying at the highest levels of credit quality. When a recession appears, credit widening is sure to follow; and corporate spreads have already started to widen.

John R. Mousseau, CFA
Vice Chairman | Chief Investment Officer
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