(Bloomberg) — The shortest-dated municipal bonds sold off after a blowout jobs report caused investors to recalibrate the odds of another big interest-rate cut from the Federal Reserve.

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On Friday, yields on three-month AAA municipals shot up 29 basis points — the biggest one-day jump since 2022 — after labor data showed a still strong US economy. That puts yields on the ultra-short securities higher than AAA municipal bonds maturing in 16 years — deepening once again, an already pronounced inversion of the muni curve.

Short-term state and local debt yields have been elevated compared to longer term debt for over two years. The muni curve inverted after the Federal Reserve started on its rate hiking regime in 2022. That relationship was just starting to return to normal — until the too hot jobs data shook traders’ conviction in the scope of the Fed’s future policy easing.

Muni bonds extended the selloff Monday, with the 10-year AAA benchmark yield edging up three basis points.

Mikhail Foux, head of municipal research and strategy at Barclays Plc, said state and local debt is reacting in tandem with US Treasuries.

“Whatever happens in our market — typically it’s derivative what’s happened in the Treasury market,” he said. Expectations for less aggressive Fed rate cuts directly affect what happens on the front end of the muni curve, he added.

Chad Farrington, co-head of municipal bond strategy at DWS Group, said the market is reflecting the repricing of Fed cuts. “The front end, inside of five years, is really going to follow the Fed and what the market is thinking there,” he said.

Longer-dated municipals have been outperforming compared to Treasuries, but that could be because state and local debt tends to lag those moves.

JPMorgan Chase & Co. strategists expect muni bonds to eventually follow the broader selloff in Treasuries. The muni market is also contending with a surge in supply ahead of the presidential election in November, which could also weigh on prices.

“We expect that tax-exempt rates will reset higher in sympathy with the UST market, particularly given expected heavy supply weeks approaching the election,” the strategists said.

–With assistance from Amanda Albright.

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