December CPI Inflation Data and Treasury Market Response

Tuesday's December CPI report delivered encouraging news for markets, with core inflation rising just 0.2% month-over-month versus the 0.3% consensus, bringing the year-over-year reading to 2.6%—the slowest pace since March 2021. Headline inflation matched expectations at 2.7% annually. Treasury yields initially declined on the release, with the 10-year touching an intraday low of 4.16%. However, subsequent labor market data would reverse these gains as the week progressed.

Treasury Auction Demand Remains Solid: The week's 10-year note auction cleared at 4.173% with no tail, indicating demand matched pre-auction expectations. Indirect bidders (foreign central banks and institutions) absorbed approximately 69.5% of the offering, consistent with recent averages. The 30-year bond auction priced at 4.825%, up 5.2 basis points from the prior auction but with strong non-dealer participation signaling genuine real-money demand. These results suggest the market's appetite for duration remains intact despite the political uncertainty surrounding Fed leadership.

Credit Spreads Hold Near Historic Tights

Credit markets demonstrated remarkable resilience during the week, with spreads holding near historic tights despite the institutional uncertainty surrounding the Fed. Investment grade spreads actually tightened 2 basis points to 71 bp—the 8th percentile of the five-year range. High yield widened just 5 basis points to 235 bp, remaining at the 2nd percentile. The VIX rose modestly to 15.86, reflecting some hedging activity ahead of the long weekend, but the credit market's refusal to price meaningful risk premium underscores the technical strength of the current environment.

Primary Market Supports Tight Spreads: Corporate bond issuance remained robust with approximately $37 billion in investment grade supply in the first week of January alone. Barclays projects full-year 2026 IG issuance of $2.46 trillion, which would exceed the 2020 record by nearly 12%. Technology issuers tapping markets for AI infrastructure funding dominated deal flow. Despite heavy supply, spreads compressed as demand from yield-seeking investors outpaced new issuance. Default rates remain benign at approximately 1.7% par-weighted globally, providing fundamental support for tight valuations.

Federal Reserve Policy Outlook

The Federal Reserve enters its January 28-29 meeting with data supporting continued patience on rate adjustments. The combination of moderating inflation and resilient growth removes urgency for near-term cuts, while the political environment around Fed leadership introduces unusual uncertainty into longer-term policy expectations. Markets are pricing approximately 97% probability of unchanged rates at the January meeting, with the first 25 basis point cut not fully priced until June.

The DOJ investigation of Chair Powell has complicated the policy outlook in ways that extend beyond traditional economic analysis. Powell stated via video that he will not resign before his term expires in May 2026 and emphasized that the Fed makes decisions "based on our best assessment of what will serve the public, rather than following the preferences of the President." His chair term expires May 15, 2026, though his governor seat runs through January 2028—raising the prospect of prolonged institutional uncertainty. The Supreme Court arguments on January 21 regarding limits on executive authority over the Fed may provide clarity on the legal boundaries of this conflict.

Week Ahead: PCE Data and Fed Independence Case

• Martin Luther King Jr. Day (January 20): US bond markets closed for the federal holiday.
• Supreme Court (January 21): Arguments scheduled on Federal Reserve independence case may clarify legal constraints on executive branch interference with monetary policy.
• PCE Inflation (January 23): The Fed's preferred inflation measure for December will be closely watched following the benign CPI report. Core PCE expected around 2.7% year-over-year.
• GDP First Estimate (January 24): Q4 2025 advance estimate expected to show continued above-trend growth, supporting the Fed's patient stance.
• Treasury Auctions: 2-year and 5-year note auctions scheduled for Tuesday and Wednesday following the holiday, testing demand in the new political environment.

US Economic Positioning and Global Context

The United States continues to demonstrate economic outperformance relative to other major economies, though the political environment surrounding monetary policy independence introduces risks that are difficult to quantify. The dollar index remains firm near 99.25, supported by growth differentials and the relatively higher yield environment. Oil prices declined to $59.44 per barrel as geopolitical tensions with Iran moderated following signals that the administration would refrain from immediate military action.

Global central bank policy continues to diverge, with the ECB maintaining rates at 2% as eurozone inflation hit exactly 2.0% in December. The Bank of Japan's regional reports suggest continued path toward additional rate hikes from the current 0.75% level. The PBOC cut structural lending rates by 25 basis points, signaling further easing capacity. This divergence supports continued dollar strength but creates cross-currents for US fixed income as relative value considerations compete with domestic policy uncertainty.