Fixed Income Market Comments

Strategy Fixed Income Weekly Fixed Income Market Comments Weaker economic data and comments from a couple of Federal Reserve Board Governors, who tend to not to speak often as the Federal Reserve District Presidents, who indicated that they do not believe raising interest rates in 2015 is necessary sent interest rates lower last week. The yield on the benchmark 10-year Treasury note fell below the 2.00% level again last week before rebounding to 2.03% at the close on Friday. For the week the 10-year note yield fell six basis points (bps) while the two-year note fell three bps to 0.61% to create a 2s/10s spread of 142 bps (slope of the yield curve). The yield on the 30-year Treasury bond fell four bps to 2.88% (see the Treasury yield curve from Bloomberg that follows). Treasury Yield Curve Source: Bloomberg Fixed income sector yields were little changed in the past two weeks with the exception of high yield bonds which tightened by 59 bps to 7.61% as investor concerns over the problems in the energy sector abated somewhat as total return in October for the High Yield Energy sector is 4.05%. B. Craig Elder, Director Fixed Income Senior Analyst celder@rwbaird.com 312-609-5433

Spread levels were tighter over the last couple of weeks in all sectors with agency debt tightening four bps to 44 bps over comparable maturity Treasury yield levels, investment-grade corporate debt tightened by six bps to 165 bps over but the most significant tightening was in high yield where spreads were in by 59 bps to 594 bps over as the panic in high yield seen in August and September has faded in October (see the tables with data from the Barclay s Indices that follow). Fixed Income Sector Spreads Sector 1/2/09 1/4/10 1/3/11 1/3/12 1/2/13 1/2/14 1/2/15 10/2/15 10/16/15 Aggregate 215 60 55 85 51 45 48 61 58 Agencies 103 34 27 52 27 37 51 48 44 MBS 147 17 42 69 45 34 28 32 30 Corporates 555 170 154 233 138 113 131 171 165 High Yield 1,641 612 515 682 493 382 488 653 594 Source: Barclay s Fixed Income Sector Yields Sector 1/2/09 1/4/10 1/3/11 1/3/12 1/2/13 1/2/14 1/2/15 10/2/15 10/16/15 Aggregate 4.23% 3.68% 3.01% 2.28% 1.79% 2.50% 2.23% 2.26% 2.27% Treasuries 1.72% 2.46% 1.92% 1.08% 0.90% 1.45% 1.42% 1.31% 1.35% Agencies 2.52% 2.27% 1.68% 1.26% 1.07% 1.69% 1.80% 1.64% 1.64% MBS 3.96% 4.14% 3.70% 2.68% 2.27% 3.27% 2.56% 2.55% 2.55% Municipals 4.52% 3.63% 3.80% 2.82% 2.19% 3.15% 2.07% 2.15% 2.16% Municipals 6.95%* 5.58%* 5.85%* 4.34%* 3.63%** 5.22%** 3.43%** 3.62%** 3.64%** Corporates 7.67% 4.73% 4.04% 3.80% 2.74% 3.26% 3.10% 3.37% 3.35% High Yield 19.40% 9.00% 7.38% 8.14% 5.96% 5.62% 6.63% 8.20% 7.61% Source: Barclay s *Based on 35.0% top Federal Tax Rate **Based on 39.6% top Federal Tax Rate Speaking of the Fed, we attended a presentation by Chicago Fed President Charles Evans who said that he did not believe the Fed needs to raise interest rates until mid-2016 although he did add that he has colleagues on the FOMC that believe action is needed earlier than he does (no, he did not mention Jeff Lacker by name). If FOMC voting members are shifting their stance away from a 2015 interest rate hike, it would appear they are syncing with bond traders as the implied probability on fed fund futures are now less than one-in-three (only 6.0% in October and 32.3% in December). However, the FOMC has cautioned that the focus should be on the pace rather than the timing of interest rate hikes when they begin the normalization of rates process. At this point, we wish they would either raise interest rates or shut up talking about it as, in our opinion, the Fed s efforts to be more transparent is causing increased volatility in markets. Economic Highlights Previous Week Retail sales in September disappointed as American consumers appear to be banking their savings from lower energy costs rather than spending them. Overall September sales rose only 0.1% and the August sales increase of 0.2% was revised downward to unchanged. When auto sales were excluded, sales dropped 0.3% in September with a downward revision in August from a 0.1% increase to a 0.1% decrease. Both numbers were below forecasts of up 0.2% and down 0.1%, respectively. This is somewhat disconcerting to economists and analysts as consumer activity accounts for about 70% of the U.S. economy and slower spending levels may already be hurting GDP growth (see chart on the third quarter GDP forecast from the Atlanta Fed in the next section).

On a slightly brighter note Industrial Production in September fell only 0.1% which was less than the forecast of a 0.2% decline and August production was revised from a decrease of 0.4% to only 0.1%. Capacity Utilization was 77.5% in September which was higher than the forecast of 77.3% and the August number was revised upward to 77.8% from the previously reported 77.6%. Since we last published, there have been two inflation reports with the first release being the Producer Price Index (PPI) which fell 0.5% in September (falling 1.1% year-over-year) and core PPI which fell 0.3% in September (up 0.8% year-overyear). This was followed by the release of the Consumer Price Index (CPI) which fell 0.2% in September (flat year-overyear) and the core CPI which rose 0.2% during the month (1.9% year-over-year). While the Fed monitors and some FOMC members likely use the CPI and PPI numbers, they tend to prefer the Personal Consumption Expenditure (PCE) Deflator year-over-year and the PCE core year-over-year numbers that are part of the Personal Income and Personal Spending reports that will be released on October 30. PCE core year-over-year has been in the 1.2%-1.3% area for the last few months, well below the Fed s goal of 2.0% inflation. Economic Highlights This Week It s housing week with Starts and Building Permits reported on Tuesday. Housing Starts are expected to rise 1.9% to 1,147,000 in September while Building Permits are expected to fall 0.4% to 1,165,000. On Thursday Existing Home Sales for September will be reported with expectations of an increase of 1.1% to 5,370,000. Housing in the United States remains strong as interest rate levels continue to be supportive of the activity with 30-year mortgage rates remaining below 4.0%. Initial Jobless Claims, reported weekly, hit a low not seen in over 40 years last week as they fell to the 255,000 level. This week (for the week ended October 17) they are expected to rise by 10,000 to the 265,000 level. Since 1967 the average has been 360,600 per week (see chart from Bloomberg below). However, the current level remains well above the low of 162,000 seen in November 1968. Initial Weekly Jobless Claims Sources: Bloomberg and U.S. Labor Department

The Treasury Department will auction $52 billion of T-bills consisting of $26 billion of three-month bills and $26 billion of six-month bills along with $7 billion of 30-year bonds (29 year 4-month as it is the reopening of the 30-year bond issued on February 19, 2015) this week. In a related item, Secretary of the Treasury Jack Lew recently sent House Speaker John Boehner a letter stating that the U.S. Treasury will have used all of the measures that have allowed the Federal government to stay under the debt limit and that it must be raised or the Treasury will not be able to auction debt. In the letter, Secretary Lew said that at that point they would only have $30 billion to fund the government which would be far short of net expenditures on certain days, which can be as high as $60 billion. GDPNow Model Forecast for 3 rd Quarter GDP The Atlanta Fed s GDPNow model nowcast for real GDP growth in the third quarter of 2015 in the third quarter of 2015 is 0.9% on October 14, down from 1.0% on October 9. The model's nowcast for real consumer spending growth in the third quarter fell from 3.6% to 3.2% after this morning's retail sales report from the U.S. Census Bureau. This was partly offset by a 0.1 percentage point increase in the nowcast for the contribution of inventory investment to third-quarter real GDP growth following the update on retail inventories from the Census Bureau. Corporate Bond Market Comments Investment-grade spreads finished the week at 165 bps over comparable Treasury yields while high yield spreads tightened substantially, by 59 bps to the 594 bps level in the past two weeks. So far this year investment-grade spreads are 34 bps wider while high yield spreads are 106 bps wider. High yield energy spreads, at 955 (104 bps tighter in the past two weeks) bps over comparable Treasury yields, are now just 215 bps wider so far this year, according to data from Barclay s.

Investment-grade Financials are 26 bps wider this year at 144 bps, Industrials are 40 bps wider at 178 bps and Utilities are 30 bps wider for the year at 151 bps over comparable Treasury yields, according to data from the Barclay s Indices. Investment-grade corporate debt has a total return of 0.61% year-to-date while high-yield debt has a negative 0.29% total return as energy (about 15% of the high yield index) has a negative total return of 8.68% year-to-date, according to data from Barclay s. Preferred stock issues have a total return this year of 5.37% while leveraged loans have a total return of 2.09%, according to data from BofA Merrill Lynch. Investment grade bond issuance last week was $32.9 billion, up from the $14.4 billion level the week before. While investment-grade issuance has slowed from the torrid pace of the summer it has been steady so far this month. In contrast, high yield issuance has been slow with only one deal completed last week for $1 billion. High yield issuance in October has only been $3.9 billion with $2.5 billion of the issuance in split-rated deals. The calendar remains light for the rest of the month but spread tightening in the sector could result in a pickup in issuance in the last two months of the year. Moody s Covenant Quality in September Rebounds from Worst on Record Moody s recently reported that the improvement in the covenant quality of September s bonds resulted in the CQI rebound to 4.33 from 4.53 in August (its weakest recorded score). However, Moody s said that the September CQI continues to reflect weakest-level covenant protection, with the index 96 basis points weaker than the record-best score of 3.37 in April 2011 (the index is a three-month rolling average CQ score weighted by each month s total number of bond issues. A lower score denotes stronger covenant quality on our scale from 1.0 to 5.0). Single A Investment-Grade Yield Curve Source: Bloomberg Composite Single A Corporate Bond Yield Curve

Single B- B B+ Speculative-Grade Yield Curve Source: Bloomberg Composite B Corporate Bond Yield Curve Historical Spread Levels for High Yield Bonds Sources: BofA Merrill Lynch and the St. Louis Federal Reserve Sources: Atlanta Fed GDPNow Model: Latest Forecast. October 16, 2015. BofA Merrill Lynch: BofA Merrill Lynch US High Yield Master II Option Adjusted Spread (retrieved from FRED Federal Reserve Bank of St. Louis. October 16, 2015. Barclay s Indices Bloomberg Charts Bloomberg News

Bloomberg Economic Releases CreditSights: Monday Morning Notes: Week Ended October 16, 2015. October 19, 2015. Moody s: Covenant Quality in September Rebounds from Worst on Record. October 13, 2015. U.S. Department of the Treasury: Treasury Sends Debt Limit Letter to Congress. October 1, 2015. Economic Calendar DATE TIME INDICATOR CONSENSUS PREV. REPORT 10/19 10:00 NAHB Housing Market Index 62 62 10/20 08:30 Housing Starts 1142K 1126K 10/20 08:30 Housing Starts (MoM) 1.4% -3.0% 10/20 08:30 Building Permits 1165K 1170K 10/20 08:30 Building Permits (MoM) -0.4% 3.5% 10/22 08:30 Initial Jobless Claims 265K 255K 10/22 08:30 Continuing Claims 2185K 2158K 10/22 09:00 FHFA House Price Index (MoM) 0.4% 0.6% 10/22 10:00 Existing Home Sales 5.37M 5.31M 10/22 10:00 Existing Home Sales (MoM) 1.1% -4.8% 10/22 10:00 Leading Index 0.0% 0.1% Sources: Bloomberg Financing Calendar DATE TERM APPROX. YIELD AMOUNT 10/19/15 3-Month 0.01 $26 10/19/15 6-Month 0.9 $26 Sources: Bloomberg

Treasury Yield Sources: Bloomberg For more information please contact your Financial Advisor.

SUMMARY OF KEY FIXED INCOME MARKET INFORMATION WEEK ENDING : 10/16/2015 TODAY WEEK AGO MONTH AGO YEAR AGO BOND BUYER REVENUE INDEX 4.07% 4.07% 4.06% 4.46% BOND BUYER 20-BOND INDEX 3.68% 3.68% 3.69% 3.87% BOND BUYER 11-BOND INDEX 3.19% 3.19% 3.21% 3.72% REPRESENTATIVE MUNICIPAL BOND YIELDS (Source: Bloomberg) AAA RATED G.O.s 2 Year 0.54% 0.54% 0.59% 0.39% 5 Year 1.23% 1.24% 1.41% 1.13% 10 Year 2.07% 2.08% 2.27% 1.87% 15 Year 2.55% 2.52% 2.70% 2.48% 30 Year 3.09% 3.14% 3.15% 2.88% PRIME RATE (Source: Bloomberg) 3.25% 3.25% 3.25% 3.25% DISCOUNT RATE (Source: Bloomberg) 0.75% 0.75% 0.75% 0.75% FEDERAL FDS AVG (Source: Bloomberg) 0.25% 0.25% 0.25% 0.25% COMMERCIAL PAPER 30 Day 0.10% 0.10% 0.10% 0.05% {PRIME ISSUERS} 60 Day 0.14% 0.13% 0.21% 0.07% Bond Equivalent Yield 90 Day 0.16% 0.18% 0.25% 0.10% (Source: Bloomberg) AGENCY DISCOUNT NOTES * 30 Day 0.04% 0.04% 0.06% 0.04% Bond Equivalent Yield 60 Day 0.08% 0.06% 0.08% 0.05% 90 Day 0.11% 0.10% 0.18% 0.05% TAXABLE 7-DAY FLOATER 0.35% 0.34% 0.34% 0.30% (Source: ) TAX FREE 7-DAY FLOATER Non-AMT 0.02% 0.02% 0.02% 0.04% (Source: ) AMT 0.24% 0.24% 0.24% 0.26% U.S. TREASURY BILLS 3 Month 0.00% 0.00% 0.08% 0.02% Bond Equivalent Yield 6 Month 0.07% 0.07% 0.23% 0.04% (Source: Bloomberg) GOVERNMENTS 2 Year 0.61% 0.65% 0.71% 0.36% (Source: Bloomberg) 5 Year 1.34% 1.42% 1.56% 1.40% 10 Year 2.02% 2.12% 2.16% 2.19% 30 Year 2.86% 2.95% 2.81% 2.96% CORPORATE A FINANCE YIELDS (Source: Bloomberg) 2 Year 1.45% 1.49% 1.57% 1.00% 5 Year 2.53% 2.60% 2.71% 2.15% 10 Year 3.56% 3.64% 3.74% 3.35% 30 Year 4.55% 4.62% 4.55% 4.38% CORPORATE A UTILITY YIELDS (Source: Bloomberg) 2 Year 1.40% 1.46% 1.47% 0.91% 5 Year 2.41% 2.48% 2.52% 1.91% 10 Year 3.34% 3.43% 3.45% 2.92% 30 Year 4.27% 4.35% 4.25% 3.98% CORPORATE A INDUSTRIAL YIELDS (Source: Bloomberg) 2 Year 1.14% 1.18% 1.25% 0.80% 5 Year 2.25% 2.32% 2.40% 1.84% 10 Year 3.24% 3.34% 3.41% 2.98% 30 Year 4.19% 4.29% 4.25% 3.98% CDs 1 Year 0.65% 0.65% 0.70% 0.50% (Source: ) 2 Year 1.15% 1.15% 1.30% 1.10% 5 Year 2.20% 2.20% 2.40% 2.20% 10 Year 2.85% 2.85% 3.00% 3.15% * Yields presented represent the prevailing market price as of 10/15/2015 and are not representative of a specific issue.

Municipal Yield Curve General Obligations - Yields as of 10/16/15 Time (Yrs) Year "AAA" Pre-re Insured "AA" "A" "BAA" 1 2016 0.23 0.23 0.31 0.27 0.39 0.78 2 2017 0.55 0.56 0.69 0.61 0.74 1.25 3 2018 0.76 0.78 0.94 0.84 1.00 1.51 4 2019 0.96 0.98 1.21 1.05 1.28 1.77 5 2020 1.20 1.22 1.49 1.31 1.57 2.04 10 2025 2.02 2.49 2.22 2.57 2.99 15 2030 2.53 3.06 2.77 3.15 3.53 20 2035 2.81 3.34 3.05 3.43 3.81 25 2040 3.00 3.53 3.24 3.62 4.00 30 2045 3.07 3.60 3.31 3.69 4.07 4.00 3.50 3.00 2.50 Muncipal Yield Curves (AAA, AA, A) Yield 2.00 1.50 1.00 0.50 "AAA" "AA" "A" 0.00 1 2 3 4 5 10 15 20 25 30 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

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 2015 Incorporated.