Updated: 11-27-2015

The economic data were mixed last week.  That led to some finicky movement in the fixed income markets along with the ongoing weakness in commodity prices, namely oil and copper, and the minutes from the October 27-28 Federal Open Market Committee (FOMC) meeting, which again put market participants on notice that a December rate hike remains a real possibility (and ideally the Fed's preferred outcome).

With the latter in mind, the fed funds futures market lifted the probability of a hike at the December 15-16 FOMC meeting to 74% from 64%.  That move was also helped along by some firm Consumer Price Index (CPI) data earlier in the week.

11/20/2015 11/13/2015 Change
Fed Fund Futures Rate Prediction Dec. 2015 (73.6%) Dec. 2015 (63.9%) ---
10yr Treasury - 2yr Treasury 133 bps 142 bps -9 bps
High Yield - 10yr Treasury 597 bps 589 bps 8 bps
Corp A - 10 yr Treasury 125 bps 128 bps -3 bps
10 yr Bund - 10 yr Treasury -176 bps -170 bps -6 bps
5yr, 5yr Forward Inflation Breakeven 1.88% 1.82% 6 bps

The Empire Manufacturing Index on Monday was weaker than expected.  The Philadelphia Fed Index on Thursday was stronger than expected.  That pretty much summed up the nature of last week's mixed economic reporting. which featured in-line CPI data, weaker than expected industrial production data, weaker than expected housing starts data, stronger than expected building permits data, slightly better than expected initial claims data, and an in-line Leading Indicators report.

Notwithstanding the growing probability of a rate hike at the December FOMC meeting, there was a decided curve flattening trade in play last week.  To that end, the spread between the 2-yr note and the 10-yr note narrowed by nine basis points to 133 basis points.

That is the narrowest the spread has been since the start of April and reflects some underlying angst that the economy is not ready to handle a move higher in interest rates.  At the least, it reflects a belief anyway that a higher policy rate will serve to dampen the inflation outlook.

With oil continuing to struggle to move higher and flirting with a break of $40.00 per barrel throughout the week, high-yield spreads continued their widening move, rising eight basis points to 597 basis points.  That is the highest level since early October.

Investment-grade spreads, however, came in three basis points to 125 basis points as a search for quality perked up amid ongoing concerns about the economic outlook.


Elsewhere, the spread between the 10-year German bund and the 10-yr Treasury widened by six basis points to 176 basis points.  That was a byproduct of the yield on the German bund coming in more than the yield on the 10-yr note (8 basis points versus 2 basis points).

Some flight-to-quality to the bund in the wake of concerns about terrorism in Europe following the Paris attacks, and some speculation that the ECB will be moved by those attacks to bolster its policy stimulus, helped drive buying interest in the bund. 

The five-year, five-year forward inflation breakeven increased 6 basis points to 1.88%.  Even so, it's a stretch to say that there are real concerns about inflation pressures picking up in the near term.

The forward inflation breakeven rate is 40 basis points lower than it was a year ago.

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