Duration & Credit Pulse
Executive Summary
Bottom Line: The Federal Reserve maintained its "patient" stance at 4.25-4.50% amid heightened dual-sided risks, marking the first explicit acknowledgment of both inflation and unemployment threats since the hiking cycle began. Treasury yields rose modestly with 10-year climbing 7bp to 4.38%, while credit markets demonstrated resilience with high yield spreads tightening 9bp to 336bp despite manufacturing and services PMIs both slipping into contraction territory—signaling stagflationary risks that position markets for Moody's historic sovereign downgrade just days ahead.
Duration Dashboard
| Maturity | May 4, 2025 | May 11, 2025 | Weekly Δ | 5-Year Percentile |
|---|---|---|---|---|
| 2‑Year | 3.83% | 3.89% | +6 bp | 52nd %ile (middle range) |
| 5‑Year | 3.92% | 4.00% | +8 bp | 67th %ile (elevated) |
| 10‑Year | 4.31% | 4.38% | +7 bp | 87th %ile (very elevated) |
| 30‑Year | 4.79% | 4.84% | +5 bp | 97th %ile (extreme) |
Curve Flattens as Long-End Approaches Historic Extremes
Curve Analysis: The Treasury curve exhibited modest bear flattening during the week, with short-term rates rising 6-8 basis points versus 5 basis points for the 30-year bond. The 30-year yield at 4.84% reached its 97th percentile of the past five years, signaling extreme levels that foreshadow funding stress ahead. The relatively contained moves masked significant intraweek volatility following the FOMC meeting, where the 10-year briefly touched 4.60% before recovering. The 2s10s spread compressed to 49 basis points from 48bp, while 5s30s narrowed to 84bp from 87bp, reflecting growing concerns about the Fed's ability to ease even as economic momentum wanes.
The FOMC's May 7 decision to maintain rates at 4.25-4.50% came with notably revised language that acknowledged "risks to both higher unemployment and higher inflation have risen"—marking the first explicit recognition of dual-sided risks since the current cycle began. Fed Chair Powell characterized the central bank as effectively "sidelined" until trade policy uncertainty clears, following April's "Liberation Day" tariff announcements. Market pricing shifted dramatically during the week, with Fed funds futures reducing expectations from three cuts to just two for 2025, pushing the first anticipated cut from June to September.
Credit Pulse
| Metric | May 4, 2025 | May 11, 2025 | Weekly Δ | 5-Year Percentile |
|---|---|---|---|---|
| IG OAS | 93 bp | 90 bp | -3 bp | 45th %ile (middle range) |
| HY OAS | 345 bp | 336 bp | -9 bp | 32nd %ile (tight) |
| VIX Index | 22.68 | 21.90 | -0.78 | 65th %ile (elevated) |
Credit markets staged an impressive recovery from April's tariff-induced selloff, with high yield spreads tightening 9 basis points to 336bp—still at just the 32nd percentile of the 5-year range. Investment grade spreads compressed modestly to 90bp, reflecting steady demand from yield-hungry investors despite mounting fundamental concerns. The disconnect between tightening spreads and elevated VIX at the 65th percentile suggests credit investors are fighting the last war, reaching for yield just as the cycle turns.
US Macroeconomic Assessment – Stagflation Signals Flash Red
The week of May 4-11, 2025 delivered a toxic combination of weakening growth and persistent inflation that left policymakers paralyzed. The employment report provided temporary relief as non-farm payrolls rose 139,000 versus 130,000 expected, though unemployment held at 4.2%. However, the more concerning signal came from weekly jobless claims jumping to 247,000—an eight-month high—suggesting emerging labor market softness concentrated in manufacturing sectors devastated by tariff uncertainty.
Inflation's Goldilocks moment proves fleeting: May CPI data offered the week's most dovish surprise, decelerating to just 0.1% monthly (2.4% yearly), with core CPI also printing at 0.1% monthly (2.8% yearly). The cooler-than-expected reading allowed Treasury yields to retreat from post-tariff highs, with the 10-year touching 4.60% before settling at 4.38%. Yet beneath the benign headline, the details revealed building pipeline pressures: shelter costs remained sticky at 0.4% monthly, while transportation services surged 0.9% as companies passed through higher logistics costs from trade disruptions.
Twin PMI contraction signals recession risk: The ISM data painted an increasingly dire picture of the real economy. Manufacturing PMI fell to 48.5—the third consecutive contractionary reading—with the imports index cratering to 39.9, the lowest since May 2009. More alarming was Services PMI dropping to 49.9, the first sub-50 print since June 2024. Given services represent 80% of US economic activity, this synchronized contraction suggests tariff impacts have metastasized beyond goods producers. New orders indices for both surveys remained mired in contraction territory, pointing to continued near-term weakness.
Housing market cracks widen: The residential sector provided another growth headwind as starts plunged 9.8% to 1.256 million units—a five-year low—while building permits fell 2.0% to 1.393 million. Single-family permits dropped 2.7% as builders reported materials costs spiking 15-20% from tariffs on Canadian lumber and Chinese fixtures. With mortgage rates hovering near 7.5% and affordability at 40-year lows, the housing market's traditional role as economic stabilizer has evaporated.
Federal Reserve Policy Outlook
The Federal Reserve's acknowledgment of "dual-sided risks" at the May meeting represents more than semantic evolution—it signals recognition that the Powell Fed faces constraints unlike any since the Volcker era. Staff economists' dramatically divergent forecasts presented to the Committee—GDP projections lowered while inflation projections raised—capture the stagflationary bind. The Summary of Economic Projections due at the June meeting will likely show the first increase in long-run neutral rate estimates since 2019, acknowledging that structural forces from deglobalization have permanently raised r-star.
Market pricing has undergone a sea change, with the first rate cut pushed to September and only 50 basis points of total easing priced for 2025—down from 125bp in January. More concerning, eurodollar futures have begun pricing rate hikes for 2026 as markets grapple with the possibility that 4.25% may prove insufficiently restrictive if tariff passthrough accelerates. The Committee's decision to slow balance sheet runoff from $25 billion to just $5 billion monthly in June reflects growing concerns about reserve scarcity, particularly as foreign central banks reduce Treasury holdings amid dedollarization efforts.
Week Ahead: Sovereign Risk Takes Center Stage
- Retail Sales (May 14): April data critical for gauging consumer resilience. Consensus -0.3% as tariff front-loading exhausts.
- Industrial Production (May 15): Manufacturing weakness expected to deepen with -0.5% forecast.
- Housing Starts (May 16): Further deterioration likely as builders pull back amid cost pressures.
- Moody's Sovereign Review: Rating agency decision on US credit rating could roil Treasury markets.
- Treasury Auctions: $40B 10-year and $24B 30-year auctions test foreign appetite at elevated yields.
US Economic Positioning and Global Context
The United States enters a critical phase where cyclical economic softening collides with structural fiscal deterioration and unprecedented trade policy uncertainty. The dollar's 10% decline from January highs—with DXY trading near 99.88—reflects growing international concern about American policy coherence. Yet perversely, this dollar weakness coincides with reduced foreign demand for Treasuries, breaking the traditional correlation that has anchored global financial markets for decades.
The sovereign credit reckoning approaches: America's fiscal trajectory has become mathematically unsustainable, with interest costs exceeding $1 trillion annually while Congress debates tax cuts that would add $4 trillion to deficits. The Peterson Foundation's calculation that every American household now owes $280,000 in federal debt crystallizes the intergenerational burden. Foreign holdings of Treasuries have stagnated near $7.5 trillion even as issuance explodes, forcing domestic investors to absorb unprecedented supply. The May 21 auction tail presages funding difficulties ahead. For fixed income investors, the week crystallized a new regime: the Fed constrained by stagflation, credit markets priced for perfection despite multiplying risks, and sovereign creditworthiness itself now in question. The relative calm in spreads and modest yield backup belie the fundamental repricing underway. As one veteran trader noted, "The market is trading like it's 2017, but the macro setup looks more like 1973." Those reaching for yield at current levels may discover they're catching the proverbial falling knife.
Key Articles of the Week
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Federal Reserve issues FOMC statementFederal ReserveMay 7, 2025Read Article
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FOMC Minutes, May 6-7, 2025Federal ReserveMay 7, 2025Read Article
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Fed sees rising risks to economy as it leaves rates unchangedReutersMay 7, 2025Read Article
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Services PMI® at 49.9%; May 2025 Services ISM® Report On Business®PRNewswireMay 5, 2025Read Article
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Wall Street stocks buoyed by strong economic data, possible US-China trade talksReutersMay 2, 2025Read Article
