Bond markets have muted response to Fed 25bp rate cut

Municipals were firmer Wednesday as U.S. Treasury yields rose and equities ended mixed after the Federal Reserve cut interest rates 25 basis points.

Ahead of the Federal Open Market Committee’s decision, municipals were slightly firmer, while short-term UST yields rose.

Following the Fed’s announcement, munis remained somewhat rich, while short-term USTs erased their losses and were little changed across the curve around 2 p.m.

Despite the small movement, the bond market [mostly] shrugged off the announcement,” said Luis Alvarado, global fixed income strategist at Wells Fargo Investment Institute. “Bond market reaction right after the announcement has been fairly muted.”

However, throughout Fed Chair Jerome Powell’s speech, USTs became slightly richer, where the 10-year briefly fell below 4%, before USTs cheapened across the curve.

By the close, muni yields were bumped up to four basis points, depending on the curve, while UST yields rose two to five basis points.

At first, there was a little bit of a rally in the markets. “Markets felt good and liked the news, and therefore we had everything kind of tick up a little bit in terms of rates,” but since then, “we’ve backed off,” said Chris Brigati, managing director and CIO at SWBC, though he noted bond markets still had a mostly muted response to the Fed decision and Powell’s speech.

The FOMC’s decision “signals that the battle against inflation is giving way to growing concerns about economic growth and most importantly, labor market softness,” said Tom Kozlik, head of public policy and municipal strategy at HilltopSecurities.

This should be seen as a turning point for investors, as “the era of attractive tax-exempt yields is already winding down, and the window to lock in favorable rates is narrowing by the day,” he said.

“The shift in policy is not just symbolic; it is actively reshaping the yield curve, impacting absolute yields and influencing investor behavior,” Kozlik noted.

This change also shows a “broader recalibration of risk and return expectations across fixed-income markets and investors should be prepared to adjust strategies accordingly,” he said.

Supply has “tailed off” a little bit compared to the summer months, but it should pick back up in October, a historically busy month for issuance, said Jeff Timlin, a partner at Sage Advisory.

Market participants may want to get some of these deals done prior to yearend, he said.

Additionally, with lower rates, “you would think that some deals that are maybe a little more rate-sensitive would be apt to accelerate that [timeline] since we’ve come down.”

The two-year muni-UST ratio Wednesday was at 56%, the five-year at 59%, the 10-year at 70% and the 30-year at 90%, according to Municipal Market Data’s 3 p.m. ET read. ICE Data Services had the two-year at 57%, the five-year at 58%, the 10-year at 70% and the 30-year at 90% at a 4 p.m. read.

The two- and five-year ratios are very rich as ratios remained below 60%, Timlin said.

“That’s where people have been migrating … dipping their toe in the water,” he said.

Additionally, where market participants are purchasing lends itself to the ratios, Timlin noted.

Separately managed accounts are driving the front-end ratios five years and in, as SMA platforms are short to intermediate buyers, while mutual funds and exchange-traded funds are long-end buyers, he said.

The Investment Company Institute Wednesday reported inflows of $2.371 billion for the week ending Sept. 10, following $158 million of outflows the previous week. This is the largest inflow figure year-to-date.

Exchange-traded funds saw inflows of $1.963 billion after $429 million of inflows the week prior, per ICI data.

Because of the reduction of AUM of mutual funds into SMAs and ETFs, that is pushing the buyer base away from the long end into the front and intermediate end, Timlin said.

There remains a supply/demand imbalance where there is demand for front-end paper, but supply is out long, he said.

This dynamic has shifted in some ways but remains the same and has been magnified in other ways, Timlin said.

“That just has to do with the lack of consistent long-duration product being offered. So when it does come, it’s kind of rate-neutral to the market, just [people] always have to participate,” he said.

However, when it comes to the overall demand, there’s more height demand for front-end paper at almost any valuation, Timlin said.

AAA scales
MMD’s scale was bumped two basis points 18 years and out: The one-year was at 2.12% (unch) and 2.00% (unch) in two years. The five-year was at 2.13% (unch), the 10-year at 2.86% (unch) and the 30-year at 4.19% (-2) at 3 p.m.

The ICE AAA yield curve was bumped up to four basis points: 2.06% (unch) in 2026 and 2.00% (unch) in 2027. The five-year was at 2.10% (-1), the 10-year was at 2.81% (-3) and the 30-year was at 4.19% (-3) at 4 p.m.

The S&P Global Market Intelligence municipal curve was bumped up to two basis points: The one-year was at 2.11% (unch) in 2025 and 1.99% (unch) in 2026. The five-year was at 2.14% (-1), the 10-year was at 2.86% (-1) and the 30-year yield was at 4.19% (-2) at 3 p.m.

Bloomberg BVAL was bumped up to two basis points: 2.03% (unch) in 2025 and 2.00% (unch) in 2026. The five-year at 2.09% (unch), the 10-year at 2.82% (-1) and the 30-year at 4.16% (-2) at 4 p.m.

Treasuries saw losses.

The two-year UST was yielding 3.545% (+4), the three-year was at 3.526% (+5), the five-year at 3.639% (+5), the 10-year at 4.069% (+4), the 20-year at 4.637% (+3) and the 30-year at 4.669% (+2) at the close.

FOMC
The FOMC cut interest rates 25 basis points, as expected, and predicted two similar cuts before yearend.

The possibility of inflation and unemployment both growing, said Wells Fargo Investment Institute’s Alvarado, creates “a big headache for the Fed,” and tariff-induced inflation could “force an early end to the cutting cycle.”

The fed funds rate target is now a range between 4% and 4.25%.

The new Summary of Economic Projections showed one official wanted to keep rates between 4.25% and 4.50% this year, six want no further cuts this year, two want one more cut, nine expect two additional easings and one wants rates lowered to a range between 2.75% and 3% this year.

“The dot plot showing two more cuts this year reinforces the notion that today is the first in a sequence of cuts and should give markets a positive boost,” said Seema Shah, chief global strategist at Principal Asset Management. Newest board member Stephen “Miran’s dissent will not have come as a surprise to anyone, but Waller’s decision to vote for a 25-basis-point cut rather than a 50-basis-point reduction should reassure market participants that the FOMC is not discarding its inflation focus for political points.”

The SEP shows “a mosaic of different perspectives and is an accurate reflection of a confusing economic outlook, muddied by labor supply shifts, data measurement concerns, and government policy upheaval and uncertainty,” Shah said.

The move at this meeting, she said, “allows the Fed to get ahead of a slowdown without overreacting to early signs of strain.”

The post-meeting statement noted economic uncertainty “remains elevated” while the “downside risks to employment have risen.”

Miran cast the lone dissenting vote, seeking a half-point rate reduction.

“The skew of the dot plot indicates that the Fed is likely to deliver 25bp cuts in October and December on top of today’s reduction,” said Simon Dangoor, head of fixed income macro strategies at Goldman Sachs Asset Management.

The doves on the board “are now in the driver’s seat,” he said. “We think it would take a significant upside surprise in inflation or labor market rebound to take the Fed off its current easing trajectory.”

The move will likely “boost short-term sentiment for risk assets, with the stock market expected to benefit,” said Richard Flax, chief investment officer at Moneyfarm. The cut “offers modest relief, but the broader message is one of caution rather than a pivot towards rapid easing.”

Olu Sonola, head of U.S. economic research at Fitch Ratings, said, “What’s striking is the lack of consensus around 2026,” which suggests the Fed may be on hold early next year, “navigating inflation risks as they emerge rather than preempting them.”

In his press conference, Powell said, “There wasn’t widespread support at all for a 50-basis-point cut today.”

He added that he believes the Fed was right to wait until now to act as employment weakens. “You could think of this as a risk-management cut,” Powell said in response to a question.

The changes in the dot plot, Powell said, are a result of differing interpretations of the labor market, which “mean different things for different people.”

The varied opinions in the dot plot are “very unsurprising given the very unusual, historically unusual nature of the challenges that we face.”

While the economy isn’t bad, he said, “there are no risk-free [policy] paths now.”

“Participants appear just a little more comfortable with easing, both a little sooner and little further than they were in June,” said FHN Financial Chief Economist Chris Low.

This was not a pivot, but “a complete U-turn,” said Jamie Cox, managing partner for Harris Financial Group. “Markets seem to like what they see.”

“The most encouraging part of this statement is the 11-1 decision, giving a sense of greater unanimity than what we were expecting,” said Jeffrey Roach, chief economist for LPL Financial. “As the risks to labor markets rise, we should expect further cuts in October and December.”

Future rate cuts will depend on what happens with the labor market, said Doug Tommasone, a senior portfolio manager of fixed income at Fiduciary Trust International.

If there is further deterioration in labor market, the rates complex is going to be hyperattuned to what can get the Fed moving further on their kind of rate-cutting trajectory over the next 18 months, he said.

“The Fed is in a tough spot,” said Jack McIntyre, portfolio manager at Brandywine Global. “They expect stagflation, or higher inflation and a weaker labor market. That is not a great environment for financial assets.”

As for the wide range of dots in the SEP, he said, it “probably means more volatility in financial markets next year.”

The Fed believes “swift, sharp action over the coming months will deliver real results for the economy,” said James Knightley, chief international economist at ING. “The market is not convinced by these softest of soft-landing projections and thinks the Federal Reserve will probably need to do more with an additional 2-3 cuts now priced over and above the Fed forecasts. This would get the Fed funds rate below 3% in 2H 2026.”

“The split of dots on the dot plot is something to behold,” said Bill Adams, chief economist for Comerica Bank. “The Fed is in a pickle, with inflation pulling them one way and a softening job market pulling the other.”

Gary Siegel contributed to this report