CPI report sets the stage for increased but still slim odds of January rate cut

Munis were steady as U.S. Treasuries saw small gains and equities ended up after an economic report showed inflation was cooling.

Following the release of the report, "odds of a January rate cut rose from 24% to 29%," noted FHN Financial Chief Economist Chris Low.

Muni yields were bumped a basis point, while UST yields fell two to four basis points.

"While one good inflation report may not be enough to trigger a follow-up rate cut in late January (indeed, Treasury yields fell [slightly] on the report), a move in March is likely if progress in reducing inflation continues in the new year," said Sal Guatieri, senior economist at BMO.

The two-year muni-UST ratio Thursday was at 70%, the five-year at 66%, the 10-year at 67% and the 30-year at 88%, according to Municipal Market Data's 3 p.m. EDT read. ICE Data Services had the two-year at 69%, the five-year at 64%, the 10-year at 66% and the 30-year at 87% at a 4 p.m. read.

"Year-end dynamics are in effect, with supply winding down and portfolio squaring driving momentum," said Kim Olsan, senior fixed income portfolio manager at NewSquare Capital.

The New York City Transitional Finance Authority sold $1.83 billion into a "solid order book."

Final yields on the last mega deal of the year were "pared across several maturities, with a $133 million tranche of 10-year 5s yielding 3.12%, or +37/MMD (for a top-bracket New York buyer, the tax equivalent yield would be about 6.35%)," Olsan said.

Only premium coupons were "implemented" in the two- to 30-year structure, she said.

Including Wednesday's NYC TFA deal, there have been 45 $1 billion-plus deals this year, Olsan said.

And with the forecasted increase in supply in 2026, there are likely to be around the same number of billion-plus deals, potentially even more, she said.

"Long-end credit is showing signs of a pullback ? [unrated] Buckeye, Ohio, Tobacco 5s in 2055 are trading around 6.40%, the highest yield for the bond since August," Olsan said. "Secondary activity points to portfolios being aligned for the coming year."

"Heavier bid-list volume on the short end brought tighter levels, with many items going into orders and resetting 1?3-year spot levels lower: Ohio [general obligation bond] 5s due 2027 were sold at 2.44% (+0/MMD), and Wisconsin GO 5s in 2028 traded at 2.46% (+3/MMD)," she said.

"A segment of inquiry is likely finding some defensive comfort in high grades" until supply "reengages" next month, she said.

Munis are down 0.16% month-to-date. The 1-2 year and the 2-4 year ranges are seeing the largest gains this month, with returns of 0.20% and 0.19%, respectively.

Elsewhere, muni credit fundamentals remain strong, largely driven by substantial COVID-era federal aid and strong economic growth, said Goldman Sachs (GS) strategists.

"State and local revenues grew significantly during this period and conservative budgeting allowed governments to bolster reserves, reduce debt and improve pension funding," they said.

Since fiscal year 2021, state reserve funds have grown as a percentage of overall expenditures, they said.

Despite some recent "spending down" of these reserves, states are estimated to end fiscal year 2025 with more than double the reserves held in fiscal year 2020, according to Goldman strategists.

"Some states have also improved controls, added protections to limit spending down rainy-day funds and introduced requirements to build up reserves when revenue growth is strong," they said.

Municipal debt as a percentage of gross domestic product has continued to fall, demonstrating, despite surging issuance, a healthier overall fiscal picture, Goldman strategists said.

Additionally, states have improved their pension funding. "The aggregate funded ratio for state and local pension plans increased to an estimated 81.4% in fiscal year 2025," they said.

These areas provide muni credit, which may be entering a period of slower revenue growth, with a strong fiscal foundation, Goldman strategists said.

Fund flows
Investors added $400.1 million to municipal bond mutual funds in the week ended Wednesday, following $26 million of inflows the prior week, according to LSEG Lipper data.

High-yield funds saw inflows of $16.7 million compared to outflows of $64.5 million the previous week.

Tax-exempt municipal money market funds saw outflows of $700.2 million for the week ending Dec. 15, bringing total assets to $145.056 billion, according to the Money Fund Report, a weekly publication of EPFR.

The average seven-day simple yield for all tax-free and municipal money-market funds was 2.44%.

Taxable money-fund assets saw $8.124 billion pulled, bringing the total to $7.464 trillion.

The average seven-day simple yield was 3.48%.

The SIFMA Swap Index was at 3.26% on Wednesday compared to the previous week's 3.11%.

AAA scales
MMD's scale was unchanged: 2.46% in 2026 and 2.41% in 2027. The five-year was 2.43%, the 10-year was 2.76% and the 30-year was 4.24% at 3 p.m.

The ICE AAA yield curve was bumped up to one basis point: 2.46% (unch) in 2026 and 2.43% (-1) in 2027. The five-year was at 2.39% (-1), the 10-year was at 2.77% (-1) and the 30-year was at 4.19% (unch) at 4 p.m.

The S&P Global Market Intelligence municipal curve was unchanged: The one-year was at 2.46% in 2025 and 2.42% in 2026. The five-year was at 2.43%, the 10-year was at 2.76% and the 30-year yield was at 4.22% at 3 p.m.

Bloomberg BVAL was bumped one basis point: 2.49% (-1) in 2025 and 2.44% (-1) in 2026. The five-year at 2.38% (-1), the 10-year at 2.72% (-1) and the 30-year at 4.13% (-1) at 4 p.m.

Treasuries were slightly firmer.

The two-year UST was yielding 3.461% (-2), the three-year was at 3.498% (-3), the five-year at 3.659% (-4), the 10-year at 4.117% (-4), the 20-year at 4.755% (-3) and the 30-year at 4.799% (-3) near the close.

CPI
Economists were divided about whether the cooler-than-expected consumer price index report would mean more rate cuts in 2026, as many pointed to extenuating circumstances that could have led to the drop.

"The canceling of the October report makes month-on-month comparisons impossible," said Kay Haigh, global co-head of fixed income and liquidity solutions at Goldman Sachs Asset Management. "The truncated information-gathering process, given the shutdown, could have caused systematic biases in the data."

As such, he doesn't expect this report to have a great impact on monetary policy "given how noisy the data is."

The more accurate December CPI will be released two weeks before the next Federal Open Market Committee meeting, Haigh noted.

"All told, this is a positive report that comes with an asterisk," said Art Hogan, B. Riley Wealth chief market strategist. Adjustments were made as a result of the lack of October numbers, he said.

"The November report also includes the Black Friday phenomenon that seems to have grown into the entire month of November," Hogan added. Future reports, he said, "will likely smooth out the statistical errors that might have been present in today's report."

"It's just one month of data, and distortions can't be ruled out, but the sharp drop in annual inflation leaves the Fed with little excuse not to respond to rising unemployment," said Seema Shah, chief global strategist at Principal Asset Management.

With more reports expected before the next FOMC meeting, she said, these "numbers tilt the balance firmly towards the doves."

Although Principal still expects two cuts in 2026, this report "raises the odds that they'll land in the first half of the year rather than the second," Shah said.

While the numbers were better-than-expected, Chris Zaccarelli, chief investment officer at Northlight Asset Management, noted, "it's only one month's data points and they will likely fluctuate in the upcoming months, but the main concern of Fed officials who are reluctant to keep cutting is that inflation is persistently high and won't come down if they keep lowering interest rates, and at this point that doesn't look like it's the case."

The Fed "clearly" can keep cutting rates, he said.

"The inflation bump from tariffs is behind us, so the path is now clear for the Fed to lower rates again in January," said Jamie Cox, managing partner for Harris Financial Group. "There is no longer a case for restrictive monetary policy."

And while the report appears positive, Olu Sonola, head of U.S. economic research at Fitch Ratings, said, "the lack of detail and the absence of data collection during the shutdown introduce a degree of skepticism that's hard to ignore."

The report may explain why Fed Chair Jerome Powell seemed "relaxed" about inflation at his post-meeting press conference, said James Knightley, chief international economist at ING. "He suggests that the tariff impact will peak in the first quarter and we agree, thereafter, falling gasoline prices, slowing housing rents and weaker wage growth mean we are on track to get toward 2% far faster than the Fed [was]forecasting last week."

ING expects quarter-point cuts in March and June, "but the risks seem skewed toward the Fed being able to deliver more unless the jobs market starts to stabilize," he said.

Still, investors were pleased by the prospect of lower inflation, said Jennifer Timmerman, senior investment strategy analyst at Wells Fargo Investment Institute. "S&P 500 futures (were) rising in hopes the release will pave the way for a year-end Santa Claus rally. The U.S. Treasury yield curve is bull steepening as the surprisingly subdued inflation reading should put additional rate cuts back on the Fed's radar for 2026."

Inflation reports may be "bumpy" for the next few months, said Jeffrey Roach, chief economist for LPL Financial (LPLA). "We may have some more hot readings as demand ticks higher from larger-than-expected tax returns in early 2026, but we should expect inflation to cool in the latter part of next year."

"Inflation has lost its grip ? and the Fed knows it," said Gina Bolvin, president of Bolvin Wealth Management Group. "Today's CPI print gives the market what it needed: confirmation that disinflation is durable and policy relief is coming. For investors, this is the time to lean into growth with guardrails ? be selective, be strategic, and stay ahead of the curve."

The Fed will be "especially encouraged by the multi-year low in core CPI," said Bill Adams, chief economist at Comerica Bank. "The cool November inflation report further bolsters the case for additional rate cuts in 2026."

Comerica (CMA) expects 75 basis points of easing next year, he said, "with most of that reduction likely to come after Chair Powell's term ends in May."