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Economic Data:
o Last Week was Employment Week
Nonfarm Payrolls were 222,000 in June
Expectations were 178,000
Unemployment rate rose to 4.4% up from 4.3% in May
o This Week is Inflation week
PPI/PPI Core
Overall number expected to be flat
Core expected to rise 0.2%
CPI/CPI Core
Overall number expected to be up 0.1%
Core expected to rise 0.2%
This pushed 10-year German bund yields to their highest level in 18-months, hitting the 0.57% level in Friday trading, and bleeding into the
U.S. bond markets as well as the yield on the 10-year Treasury was up to almost 2.40% in Friday trading.
This week the fixed income markets will focus on the Congressional testimony of Fed Chair Janet Yellen and the inflation reports as the PPI
and CPI reports are released. We will be interested to see if House Republicans, who have been critical of the Feds easy money policies of
the past, questioning will be less hostile now that the Fed interest rate and asset holding policies have become much more hawkish
recently.
The yield on the benchmark 10-year Treasury finished the week at 2.39%, up eight bps while the yield on the two-year note was two basis
points (bps) higher at 1.40%, creating a slope of the yield curve (as measured by the 2s/10s spread) of 99 bps. Three month T-bills finished
the week at 1.0125% while three-month LIBOR continued to move higher finishing the week just over 1.30% (1.30522%) resulting in a TED
Spread of 29 bps (difference in 3-month LIBOR and 3-Month T-bill yields). The yield on the 30-year bond was nine bps higher at 2.93%
(please see the Treasury yield curve from Bloomberg that follows).
Source: Bloomberg
The Fed
The FOMC minutes from the June meeting showed that the committee is somewhat divided about the timing of the onset of the balance
sheet reduction as some of the recent economic data have been weaker than expected resulting in some members wanting to take a more
cautious approach not only to the balance sheet but future rate hikes as well.
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As noted a couple of weeks ago, the Fed indicated at its June meeting (an addendum to the statement) that it would start the runoff at $10
billion per month for a quarter ($6 billion in Treasuries and $4 billion in MBS), increasing by $10 billion every three months for 12-months until
it reaches $50 billion ($30 billion in Treasuries and $20 billion in MBS).
The dilemma the Fed faces is that despite weaker economic data, improvement in the unemployment data (currently 4.4%) is limited, equity
markets remain hot and interest rates are very low in other words the Fed is worried by the possibility of asset bubble problems. On the
other hand (in all due deference to former President Truman And his feelings about one-armed economists), some of the committee
members are concerned that the recent weakness in economic data could be a sign of weaker economic growth in 2018 with chances of a
recession in 2019 especially if they raise the funds target rate in the second half of this year (take your pick September or December)
and four times next year.
While we know that our counsel is not needed, our preference would be for a rate hike in September along with an announcement of the
runoff beginning in October then waiting until June 2018 before the next rate hike followed by one or two more hikes in the second half of
2018 September and December.
Lastly, Randall Quarles has been nominated to the Board of Governors of the Federal Reserve, as many had expected. Mr. Quarles is
currently the head of the Cynosure Group (a private investment firm) and before that he worked at the Carlyle Group (larger private equity
firm). He served as the Under Secretary of the Treasury for Domestic Finance in the George W. Bush administration. He graduated from
Columbia University and Yale Law School and is a Republican.
Only investment-grade corporate bonds and high yield bonds have positive total returns on a trailing 12-month basis. Investment-grade
corporate bonds have a 0.66% return while high yield has an 11.39% total return. Treasury debt has the weakest performance with a
negative 3.45% total return over the past year. Year-to-date, all sectors have positive returns led by high yield with a 4.60% total return
followed by investment-grade corporate bonds with a 3.40% return and municipal bonds with a 3.38% total return.
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This week is inflation week with both the PPI and CPI numbers released along with retail sales and industrial production. However, the
market will be focused on Fed Chair Janet Yellens testimony before Congress as she is in front of the House Financial Services Committee
on Wednesday and the Senate Banking Committee on Thursday. As usual, we will be looking for timing on future rate hikes and balance
sheet reduction but will not likely harvest much from her testimony.
Economic growth forecasts for the second quarter are solid with the Atlanta Feds GDPNow model forecast 2.7% growth in the quarter while
the street consensus forecast is for growth of 3.0% last quarter and 2.4% for both this quarter and the fourth quarter. The New York Feds
Nowcast forecast is lower as it is forecasting growth of only 1.9% in the second quarter and 1.6% for this quarter.
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Investment-grade corporate bonds have a 0.66% total return on a trailing-12 month basis and 3.40% year-to-date, according to data from
Bloomberg Barclays Indices. High yield bonds have an 11.31% total return for the trailing 12-months and 4.65% year-to-date, also according
to data from Bloomberg Barclays Indices. Preferred stock has a 5.76% total return on a trailing-12 month basis and an 8.89% total return
year-to-date while leveraged loans have a 7.50% total return over the past 12-months and 2.15% year-to-date, according to data from Bank
of America Merrill Lynch Indices.
Last week Moodys said that its Liquidity-Stress Index (LSI) fell to 3.5% in June from 4.2% in May which was the lowest it has been since
November 2014. They indicated that speculative-grade issuers are helped by access to debt markets that is aiding them in managing
maturities schedule and allowing them to booster their balance sheets.
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In addition, the commodity sectors have benefited from higher energy prices (relative to early 2016 prices) with the Oil & Gas LSI falling
sharply to 7.7% in June from 10.4% in May. It peaked in March 2016 at 31.6%. The lower LSI points to a lower U.S. speculative-grade
default rate which Moodys forecasts to fall to 2.7% at the end of May 2018, down from the current 3.9% default level.
CreditSights said that its U.S. High Yield issuer-weighted default rate was 5.4% at the end of June, down from 5.5% at the end of May.
When the commodity sectors are excluded, the default rate was only 3.2%. However, there was improvement in the commodity default rate
as it fell to 13.1% in June from 14.9% in May. CreditSights expressed concern about the significant stress that the retail sector is currently
experiencing. They expect the default rate of retailers will increase from the 3.1% (issuer-weighted) as 13 of the 58 retailers in the BAML
U.S. Index are trading at distressed levels (i.e. above 1,000 bps spread levels).
S&P recently reported that its U.S. speculative-grade default rate, on a trailing-12 month basis, increased to 3.8% in June from 3.6% in May
as there were five defaults during the month. Problems continue in the energy and natural resources sector which has an estimated default
rate of 18.6%. When energy and natural resources are omitted, the speculative-grade default rate is only 2.1%.
Sources: BofA Merrill Lynch, BofA Merrill Lynch US High Yield Option-Adjusted Spread [BAMLH0A0HYM2], retrieved
from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BAMLH0A0HYM2, July 7, 2017
Sources:
Atlanta Federal Reserve Bank: GDPNow. July 6, 2017.
BofA Merrill Lynch: BofA Merrill Lynch US High Yield Master II Option Adjusted Spread (retrieved from FRED Federal Reserve Bank of St Louis. July 7,
2017.
Bloomberg: Bond News
Bloomberg Barclays Indices
CreditSights: HY Defaults June 2017: U.S. Retail Focus. July 5, 2017
CreditSights: Monday Meeting Notes Yellen Up Next. July 9, 2017.
Moodys: SGL Monitor LSIs Ongoing Drop Points to Fewer Defaults. July 5, 2017.
New York Federal Reserve Bank. Nowcasting Report. July 7, 2017.
S&P: Global Fixed Income Research A Weekly Update on Global Credit Trends. July 10, 2017.
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Treasury Yield
Source: Bloomberg
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2.00 "AAA"
1.50 "AA"
1.00 "A"
0.50
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.
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SUMMARY OF KEY FIXED INCOME MARKET INFORMATION
As Of 7/10/17
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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 bonds 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 (Moodys) and Standard & Poor's Corporation (S&P).
Moodys lowest investment-grade rating for a bond is Baa3 and S&Ps 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.