No Fixed Income Report Next Week - Will Resume Week of 1/23. Fixed Income Weekly Highlights
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1 Strategy Fixed Income Weekly No Fixed Income Report Next Week - Will Resume Week of 1/23 Fixed Income Weekly Highlights Treasury yields fell last week o Slope of the curve flatter by four bps to 121 bps (2s/10s spread) Normal is bps High yield spreads were in by 26 bps last week o Spreads rose to 383 bps over comparable Treasury yields o Yield level continued to decline down 31 bps to 5.81% Forecasts from the two Fed models for GDP growth in the fourth quarter are mixed o Atlanta Fed GDPNow Forecast for fourth quarter growth is 2.9% o New York Fed Nowcast Forecast for fourth quarter growth is 1.9% 1 st quarter forecast is 1.9% Fed funds futures expect next rate hike by FOMC in June o Economists expect two rate hikes in 2017 Economist surveyed by Bloomberg forecast for bps hikes in May and December 25 bps hike in Q bps hike in Q Important Economic data released last week o Employment Report for December Nonfarm payrolls +156,00 Unemployment Rate (BLS U-3) 4.7% Average Hourly Earnings +0.4% (MoM)) Average Hourly Earnings +2.9% (YoY) Average Weekly Hours 34.3 Moody s LSI Ends Year with Upbeat Tone o LSI ended year at 5.9% Down from 6.8% at the outset of 2016 o Spec-grade default rate ended year at 5.9% Down from 5.6% current level Forecast for end of 2017 is 4.0% B. Craig Elder, Director Fixed Income Senior Analyst celder@rwbaird.com
2 Fixed Income Comments The hawkish tone to the minutes from the December FOMC meeting and an employment report that sent mixed signals to fixed income investors resulted in shorter-maturity Treasury yields moving higher and longer-maturity yields lower last week. Municipal bond yields fell while the yield level on high yield bonds continued their collapse as investors seem to be impervious to credit risk from lower-rated debt. This week s fixed income market activity will be dominated by the Treasury auctions, wholesale inflation (PPI) and the retail sales reports. Also, President Obama will make his farewell speech here in Chicago on Tuesday evening. Next week will be another short-trading week with the market closed on Monday for Martin Luther King Day while Friday s trading will likely be somewhat lighter as President-elect Trump is inaugurated. The economic data of importance are the retail inflation report (CPI), industrial activity as measured by industrial production and capacity utilization and housing data (housing starts and building permits). Treasury yields were generally lower last week in the 5s-30s section of the yield curve while the short-end of the curve saw higher yields. The yield on the benchmark 10-year note fell two basis points (bps) to 2.42% while the yield on the two year note rose two bps to 1.21%, creating a yield curve slope of 121 bps (as measured by the spread between the 2s/10s). The slope narrowed by four bps last week. The yield on the 30-year Treasury bond was six bps lower at 3.01% (please see the U.S. Treasury yield curve from Bloomberg that follows). U.S. Treasury Yield Curve Source: Bloomberg FOMC Minutes for December The minutes from the December meeting of the FOMC, that were released last week, showed that the committee seems to be shifting focus from the economic growth part of their dual mandate to the price stability part of the mandate because of worries about aggressive fiscal stimulus from the new administration. The statement said that members agreed that there was heightened uncertainty about possible changes in fiscal and other economic policies as well as their effects. The FOMC is concerned that significant fiscal policies (tax cuts for individuals and corporations and spending on infrastructure) could result in inflation accelerating at a pace that they will not be able to tolerate forcing them to raise interest rates at a faster pace than the gradual pace they prefer. With that said, we remain unconvinced that the FOMC which has been very reluctant to move rates higher is going to reverse course and begin raising interest rates three or four times a year unless inflation (as measured by the PCE core year-over-year) rises well above the 2.0% for an extended period. -2-
3 December Employment Report The nonfarm payroll number of 156,000 for December (see chart from Bloomberg that follows) was somewhat disappointing, as it was below the consensus forecast of 175,000, but that was somewhat mitigated by the upward revision (to 204,000 from 178,000) in November and the increase average hourly earnings in December of 0.4% (up 2.9% year-over-year). The report was released on Friday by the Bureau of Labor Statistics (BLS). The BLS said that job growth in 2016 totaled 2.2 million which was less that the 2.6 million experienced in October job creation was revised down to 135,000 from the previously reported 142,000 with job growth increasing by an average of 165,000 during the fourth quarter of Employment in health care remained strong with an increase of 43,000 jobs in December with most of the increase occurring in ambulatory health care services (+30,000) and hospitals (+11,000). Health care added an average of 35,000 jobs per month in 2016, slightly down from the 39,000 average in On the other side of the ledger, manufacturing declined by 63,000 in 2016 despite an increase of 17,000 jobs in December (most coming from the 15,000 gain in the durable goods component). The unemployment rate (BLS U-3 measure) increased to 4.7% in December from 4.6% in November while the underemployment rate (BLS U-6 measure) fell to 9.2% from 9.3% the previous month. The labor participation rate rose to 62.7% in December from a revised 62.6% in November (previously reported as 62.7%). The report showed that among the major worker groups, the unemployment rate for adult men was 4.4%, adult women was 4.3%, teenagers was 14.7%, whites was 4.3%, blacks was 7.8%, Asians was 2.6%, and Hispanics was 5.9%. Average weekly hours worked was unchanged at 34.3 in December from the revised November number of 34.3% (originally reported as 34.4 hours per week). The average work week for production and nonsupervisory employees remained at 33.6 hours while the work week in manufacturing was 0.1 hour higher to 40.7 and overtime edged up by 0.1 hour to 3.3 hours. Average hourly earnings rose 10 cents to $26.00 in December after falling by two cents in November. This was an increase of 0.4% in December, above expectation of an increase of 0.3%, and up 2.9% year-over-year which was above expectations of an increase of 2.8%. In December, average hourly earnings of private-sector production and nonsupervisory employees increased by seven cents to $ Nonfarm Payrolls Sources: BLS and Bloomberg -3-
4 Treasury Auctions The Treasury will sell $118 billion in securities this week consisting of $62 billion in bills on Monday ($34 billion in three-month bills and $28 in six-month bills), $24 billion of three-year notes on Tuesday, $20 billion of 10-year notes (reopening of the November auction) on Wednesday and $12 billion of 30-year bonds (reopening of the November auction) on Thursday. Sector Spread and Yield Changes Fixed income spreads were little changed last week with the exception of high yield where the spread level fell 26 bps to 383 bps over comparable maturity Treasuries. Yield levels were essentially unchanged with the exception of municipal bonds where the fell eight bps to 2.57% (13 bps to 4.33% on a tax equivalent basis) and high yield where they fell 31 bps to 5.81%. Fixed Income Sector Spreads Sector 1/3/11 1/3/12 1/2/13 1/2/14 1/2/15 1/2/16 1/3/17 12/30/16 1/6/17 Aggregate Agencies MBS Corporates High Yield Source: Barclay s Fixed Income Sector Yields Sector 1/3/11 1/3/12 1/2/13 1/2/14 1/2/15 1/4/16 1/3/17 12/30 1/6 Aggregate 3.01% 2.28% 1.79% 2.50% 2.23% 2.59% 2.63% 2.61% 2.61% Treasuries 1.92% 1.08% 0.90% 1.45% 1.42% 1.72% 1.92% 1.89% 1.90% Agencies 1.68% 1.26% 1.07% 1.69% 1.80% 2.04% 2.24% 2.21% 2.22% MBS 3.70% 2.68% 2.27% 3.27% 2.56% 2.76% 2.87% 2.85% 2.85% Municipals 3.83% 2.82% 2.19% 3.15% 2.07% 2.07% 2.65% 2.65% 2.57% Municipals 5.85%* 4.34%* 3.63%** 5.22%** 3.43%** 3.43%** 4.46%** 4.46%** 4.33%** Corporates 4.04% 3.80% 2.74% 3.26% 3.10% 3.68% 3.39% 3.37% 3.36% High Yield 7.38% 8.14% 5.96% 5.62% 6.63% 8.87% 6.01% 6.12% 5.81% Source: Barclay s *Based on 35.0% top Federal Tax Rate ** Based on 39.6% top Federal Tax Rate Three-Month Libor We recently added two new charts to the Weekly, three-month LIBOR and the TED spread. Three-month LIBOR, the rate that banks charge each other for overnight money i.e. the benchmark for bank rates globally, provides us with a better view (from the market) than other short-term interest rate measures. Three-month LIBOR was higher last-week finally rising above 1.00% (in about seven years) moving to % from % the previous week. Since early 2015, 3-month Libor has risen from % to the high of % level last previous week. -4-
5 Three-Month U.S. LIBOR Source: Bloomberg Ted Spread The TED spread is the difference between rates on three-month LIBOR and three-month T-bill rates. The TED spread is seen by the fixed income market as an indicator of perceived credit risk in the general economy. Since T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks, an increase in the TED spread is a sign that lenders believe the risk of default on interbank loans (aka as counterparty risk) is increasing. Interbank lenders, therefore, will seek higher yields, or alternatively accept lower yields from safer investments i.e. T-bills. When the risk of bank defaults is considered to be decreasing, the TED spread decreases. Note that we are using the data from the St. Louis Fed for the chart below which is lagged by one-week. The TED spread ended the period at 50 bps, unchanged from the level seen the past three weeks. -5-
6 TED Spread Source: Federal Reserve Bank of St. Louis, TED Spread [TEDRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; January 6, Fed Funds Futures The Fed s dot-plots show expectations of three 25 bps rate hikes this year. At this time, the projection from the fed funds futures is for a rate hike at the June meeting. In 2017, the economists surveyed by Bloomberg forecast the Fed will raise another 25 bps (according to the median forecast) to 0.75%-1.00% at its meeting in early May and again in December to move the target funds range to %. They have an additional 25 bps increase to 1.25%-1.50% in the first quarter of 2018 followed by a second 25 bps hike to 1.50%-1.75% in the second quarter. Fed Funds Futures Meeting Date Probability of a Rate Hike Probability of a Rate Cut 1/6/17 12/16/16 1/6/17 12/16/16 2/1/ % 12.4% 0.0% 0.0% 3/15/ % 31.3% 0.0% 0.0% 5/3/ % 42.0% 0.0% 0.0% 6/14/ % 70.8% 0.0% 0.0% 7/26/ % 74.5% 0.0% 0.0% 9/20/ % 85.2% 0.0% 0.0% 11/1/ % 87.7% 0.0% 0.0% 12/13/ % 94.0% 0.0% 0.0% Source: Bloomberg -6-
7 YTD Returns and Related Stats On a trailing 12-month basis, high yield outpaces all of the other major fixed income asset classes with a total return of 18.28% followed by 5.91% in the investment-grade corporate bond sector. The weakest performance has been in municipal bonds and Treasuries. Munis have a total return of one lousy basis point why Treasuries have a total return of 57 bps. Fixed Income Sector Total Return and Statistical Data TR-12 Yield Spread Price Coupon Maturity Duration Convexity Aggregate 2.36% 2.61% 44 $ % Treasuries 0.67% 1.90% n/a $ % Agencies 1.93% 2.22% 54 $ % MBS 1.35% 2.85% 18 $ % (1.72) IG Corporates 5.91% 3.36% 122 $ % Municipals 0.01% 2.57%/4.33% n/a $ % (1.07) High Yield 18.28% 5.81% 383 $ % (0.22) Source: Barclay s Indices Economics Economic Releases for the Week Economic Indicator Day of Release Period Survey Prior PPI (MoM) Thursday December 0.3% 0.4% PPI ex food & energy (MoM) Thursday December 0.1% 0.4% PPI (YoY) Thursday December 1.6% 1.3% PPI ex food & energy (YoY) Thursday December 1.5% 1.6% Initial Jobless Claims Thursday January 7 255, ,000 Retail Sales Friday December 0.7% 0.1% Retail Sales ex autos Friday December 0.5% 0.2% Retail Sales ex autos & gas Friday December 0.4% 0.2% Business Inventories Friday November 0.5% -0.2% Monthly Budget Statement Friday December -25.0b b Source: Bloomberg Economic Releases for the Previous Week Economic Indicator Period Actual Survey Prior Construction Spending November 0.9% 0.5% 0.6% (r) ISM Manufacturing December Initial Jobless Claims December , , ,000 (r) Nonfarm Payrolls (Change) December 156, , ,000 (r) Unemployment Rate (U-3) December 4.7% 4.7% 4.6% Average Hourly Earnings (MoM) December 0.4% 0.3% -0.1% Average Hourly Earnings (YoY) December 2.9% 2.8% 2.5% Average Weekly Hours December (r) Underemployment Rate (U-6) December 9.2% n/a 9.3% Factory Orders November -2.4% -2.3% 2.8% (r) Durable Goods Orders November F -4.5% -4.6% -1.9% Source: Bloomberg (r) - revised -7-
8 Atlanta Fed s GDPNow Model and NY Fed s Nowcast Model Forecasts for Third Quarter GDP The Atlanta Fed s GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2016 was 2.9 percent on January 6, unchanged from January 3. The forecasts of fourth-quarter real net exports and real inventory investment increased slightly after the economic releases on Friday morning. These increases were offset by slight declines in the forecasted real growth rates of consumer spending, private fixed investment, and state and local government spending after the same releases. The New York Fed s Nowcasting report calls for GDP growth of 1.9% in both the fourth-quarter of 2016 and the first-quarter of The fourth-quarter 2016 nowcast moved up 0.1 percentage point as this increase was largely due to parameter revisions. The first-quarter 2017 nowcast moved up 0.2 percentage point as this increase was mainly due to parameter revisions and positive surprises from ISM survey data. Corporate Bond Market Comments Corporate Bond Market Comments Investment-grade corporate bonds yields ended last week at 3.36% while the spread level was 122 bps (over comparable Treasury yields), both falling by one basis point. High yield spreads closed 26 bps lower at 383 bps over comparable Treasury yields (see spread chart from St. Louis Federal Reserve and Bank of America Merrill Lynch that follows) while the yield level fell 31 bps to 5.81%. Investment-grade corporate bonds have a 5.91% total return in 2016 while high yield had an 18.28% total return for the trailing 12-months, according to data from Barclay s. -8-
9 Historical Spread Levels for High Yield Bonds Sources: BofA Merrill Lynch, BofA Merrill Lynch US High Yield Option-Adjusted Spread [BAMLH0A0HYM2], retrieved from FRED, Federal Reserve Bank of St. Louis; January 6, Moody s LSI Ends the Year with Upbeat Tone Moody s reported last week that its Liquidity-Stress Index slipped to 5.9% in December from 6.0% in November and falling from the 6.8% level experienced at the beginning of Moody s said that the LSI enters this year on a much calmer tone as energy sector strains that drove liquidity weakness and pushed up defaults are moderating. The LSI (takes the total number of companies rated SGL-4 Moody s lowest liquidity rating on a scale of 1 to 4 and divides it by the total number of SGL rated companies) has a long-term average of 6.8% with a record high of 20.8% in March 2009 and a record low of 2.8% in April Moody s added that a steady stream of new speculative-grade issuance continues to provide liquidity support in addition to generally positive economic sentiment that looks to set maintain healthy cash flow. The issuance of high yield bonds and loans was up around 20% last year as investors were willing buyers as they attempted to enhance portfolio yields in a very low interest rate environment. Their speculative-grade default forecast for 2017 is 4.0%, falling significantly from the current 5.6% level but added that the prospect of higher interest rates could create selective challenges in 2017 for low-rated companies with weaker operating performance, but not in a magnitude that would replicate the level of energy defaults in Sources: Atlanta Fed GDPNow Model: Latest Forecast January 6, BofA Merrill Lynch: BofA Merrill Lynch US High Yield Master II Option Adjusted Spread (retrieved from FRED Federal Reserve Bank of St Louis. January 6, Bloomberg: Bond News Bloomberg Barclay s Indices Federal Reserve Bank of St. Louis, TED Spread [TEDRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; January 6, Moody s: SGL Monitor. January 3, New York Federal Reserve: Nowcasting Report January 6,
10 Treasury Yield Source: Bloomberg -10-
11 Municipal Yield Curve General Obligations - Yields as of 1/6/17 Time (Yrs) Year "AAA" Pre-re Insured "AA" "A" "BAA" Muncipal Yield Curves (AAA, AA, A) Yield "AAA" "AA" "A" Years Please note that these levels are representative of institutional net levels, and do not reflect retail sales credit. These yields should be used as general market indicators only. Source: Municipal Market Data -11-
12 SUMMARY OF KEY FIXED INCOME MARKET INFORMATION TODAY LAST WEEK MONTH AGO YEAR AGO BOND BUYER REVENUE INDEX 3.90% 3.90% 4.10% 3.78% BOND BUYER 20-BOND INDEX 3.78% 3.78% 4.03% 3.45% BOND BUYER 11-BOND INDEX 3.31% 3.31% 3.58% 2.96% REPRESENTATIVE MUNICIPAL BOND YIELDS (Source: Bloomberg) AAA RATED G.O.s 2 Year 1.20% 1.23% 1.17% 0.66% 5 Year 1.74% 1.80% 1.73% 1.14% 10 Year 2.26% 2.35% 2.35% 1.81% 30 Year 3.02% 3.08% 3.16% 2.78% PRIME RATE 3.75% 3.75% 3.50% 3.50% DISCOUNT RATE 1.25% 1.25% 1.00% 1.00% FEDERAL FDS AVG 0.66% 0.50% 0.41% 0.35% COMMERCIAL PAPER (PRIME) 30 Day 0.62% 0.71% 0.53% 0.06% (Source: Bloomberg) 60 Day 0.68% 0.83% 0.57% 0.08% 90 Day 0.90% 0.96% 0.65% 0.09% AGENCY DISCOUNT NOTES * 30 Day 0.50% 0.44% 0.40% 0.04% 60 Day 0.55% 0.48% 0.45% 0.06% 90 Day 0.57% 0.50% 0.53% 0.07% TAXABLE 7-DAY FLOATER 0.94% 1.00% 0.83% 0.32% (Source: ) TAX FREE 7-DAY FLOATER Non-AMT 0.92% 0.81% 0.80% 0.02% (Source: ) AMT 0.72% 0.78% 0.61% 0.24% U.S. TREASURIES (% YTM) 3 Month 0.50% 0.50% 0.53% 0.19% (Source: Bloomberg) 6 Month 0.57% 0.61% 0.63% 0.44% 1 year 0.81% 0.81% 0.85% 0.62% 2 Year 1.20% 1.19% 1.13% 0.93% 5 Year 1.90% 1.93% 1.89% 1.56% 10 Year 2.39% 2.44% 2.47% 2.12% 30 Year 2.98% 3.07% 3.15% 2.91% CORPORATE A FINANCE YIELDS (Source: Bloomberg) 2 Year 2.00% 1.99% 1.95% 1.72% 5 Year 2.81% 2.81% 2.75% 2.69% 10 Year 3.60% 3.61% 3.60% 3.62% 30 Year 4.35% 4.41% 4.50% 4.55% CORPORATE A UTILITY YIELDS (Source: Bloomberg) 2 Year 1.86% 1.86% 1.81% 1.66% 5 Year 2.58% 2.61% 2.54% 2.63% 10 Year 3.32% 3.37% 3.34% 3.53% 30 Year 4.15% 4.22% 4.32% 4.33% CORPORATE A INDUSTRIAL YIELDS (Source: Bloomberg) 2 Year 1.73% 1.73% 1.66% 1.46% 5 Year 2.52% 2.54% 2.48% 2.45% 10 Year 3.29% 3.31% 3.30% 3.39% 30 Year 4.09% 4.12% 4.23% 4.24% CDs 1 Year 1.05% 0.80% 1.00% 0.50% (Source: ) 2 Year 1.55% 1.20% 1.45% 0.85% 5 Year 2.25% 1.75% 2.10% 2.10% 10 Year 2.80% 2.05% 2.55% 3.00% * Yields presented represent the prevailing market price as of 1/6/2017 and are not representative of a specific issue. As Of 1/9/17-12-
13 Appendix Important Disclosures Some of the potential risks associated with fixed income investments include call risk, reinvestment risk, default risk and inflation risk. Additionally, it is important that an investor is familiar with the inverse relationship between a bond s price and its yield. Bond prices will fall as interest rates rise and vice versa. When considering a potential investment, investors should compare the credit qualities of available bond issues before they invest. The two most recognized rating agencies that assign credit ratings to bond issuers are Moody's Investors Service ( Moody s ) and Standard & Poor's Corporation ( S&P ). Moody s lowest investment-grade rating for a bond is Baa3 and S&P s lowest investment-grade rating for a bond is BBB-. This is not a complete analysis of every material fact regarding any sector, municipality or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. It is strongly recommended that an investor discuss with their financial professional all materially important information such as risks, ratings and tax implications prior to making an investment. Past performance is not a guarantee of future results. This report does not provide recipients with information or advice that is sufficient on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation, or need of any particular client and may not be suitable for all types of investors. Recipients should consider the contents of this report as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report. ADDITIONAL INFORMATION ON SECURITIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST BY CONTACTING YOUR BAIRD INVESTMENT PROFESSIONAL. Copyright 2017 Incorporated. -13-
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