Budget Talks Headline Following U.S. Credit Downgrade

Yield curve steepens as investors sell longer-dated Treasurys. Following yesterday’s U.S. credit downgrade that briefly sent longer-term yields soaring (but was ultimately reversed by the market close), the move resumed today. The budget deficit was again in focus with lawmakers reportedly running into hurdles during ongoing tax cut and SALT deduction negotiations. SALT advocates have reportedly threatened to block President Trump’s tax cut bill if deductions are not increased substantially, while Trump has urged Republicans to hold off on SALT discussions until the tax legislation is passed. Ultimately, the 10-year yield closed 4 bps higher at 4.49% while 20-year and 30-year yields rose 6-7 bps to 4.99% and 4.97%, respectively.

Fed President Musalem emphasizes tariff risks. Today, St. Louis Fed President Musalem said that tariffs will likely have a pronounced impact on the economy. He said, “Even after the de-escalation of May 12, they seem likely to have a significant impact on the near-term outlook,” referring to last week’s surprise tariff rollbacks between China and the U.S. He said tariffs are likely to dampen economic activity and weigh on the labor market, and that the Fed should not “look through” the possible inflationary impact of tariffs. While he added that the Fed is positioned to respond, he made it clear that Fed policy should remain focused on the possibility of higher and persistent inflation. Separately, Fed President Bostic also said today that he is comfortable with the Fed’s current policy positioning, and that further uncertainty could lead him to “push out the time that we would get to a more normal posture.”

China continues economic stimulus. The People’s Bank of China cut 1-year and 5-year loan prime rates by 10 bps to 3.0% and 3.5%, respectively. The move, announced overnight, marks the first reduction to the rates since October, where the 1-year LPR is a benchmark for corporate and household loans while the 5-year LPR is a benchmark for mortgage rates. The rate cuts are consistent with stimulus measures announced earlier in the month, which included a 10 bp reduction to the 7-day reverse repo rate and a 50 bp slash to the reserve requirement ratio enforced on banks. Chinese officials will hope that stimulus, coupled with recent tariff de-escalation, will allow the nation to hit its 5% GDP target for 2025.