Updated: 04-27-2017

U.S. Treasuries were little-changed last week and the yield curve steepened as the S&P 500 recovered from a three-week low as concern about the French presidential election subsided heading into the vote. The U.S. economic data continued to surprise on the downside, showing U.S. housing starts unexpectedly falling in March (1215K vs. Briefing.com consensus 1256K). Manufacturing production also unexpectedly declined in March, sliding by 0.4% m/m. These weaker pieces of "hard" economic data follow a surprise decline in retail sales during March. 

The regional manufacturing activity surveys were also disappointing, falling back to Earth after rocketing higher in the wake of the November 8 U.S. election. The Empire Manufacturing Index fell to 5.2 for April (Briefing.com consensus 13.0) and the Philadelphia Fed Manufacturing Survey declined to 22.0 (Briefing.com consensus 23.7). Existing Home Sales for March did manage to beat estimates at 5.71M (Briefing.com consensus 5.58M). 

The biggest move in markets last week was the steep decline in oil prices. The drop failed to ignite much buying interest in Treasuries because they have already rallied substantially over the past month, but the move in crude could still be meaningful. Front-month WTI crude lost over three dollars per barrel to end below $50/bbl. and that will affect inflation and the credit outlook for U.S. shale oil producers.

4/21/2017 4/14/2017 Change
Fed Fund Futures Rate Prediction June 2017 (53%) March 2017 (49%)  NA
10yr Treasury - 2yr Treasury 104 bps 103 bps  1 bps
High Yield - 10yr Treasury 389 bps 394 bps  -5 bps
Corp A - 10 yr Treasury 106 bps 106 bps  0 bps
10 yr Bund - 10 yr Treasury -202 bps -208 bps  6 bps
5yr, 5yr Forward Inflation Breakeven 1.88% 2.09%  -21 bps

The yield spread between the 10-year Treasury note and the 2-year Treasury note widened by one basis point to 104 bps last week. The spread remains near its narrowest level since the November 8 U.S. election. Receding hope for fiscal stimulus is part of the story as is the flattening out of oil prices around $50/bbl. The Fed's $4.5 tln balance sheet may also be flattening the yield curve. Fed officials have said that they would probably decide to begin unwinding that balance sheet later this year or early in 2018

The yield premium on high-yield debt narrowed by five basis points to 389 bps over Treasuries of comparable maturities last week. The narrowing of spreads is a little bit surprising in light of the decline in oil prices but the general rally in risky assets would justify some mild narrowing of credit spreads. 

Investment-grade corporate debt yields were steady at 106 bps over Treasuries with comparable maturities last week. Corporate bonds remain very expensive on a historical basis but corporate tax reform could cause new supply to dry up if it eliminates the deductability of interest on corporate bonds. Corporate tax changes appear to have been put on the back burner though as the debt ceiling approaches and the White House tries to keep the government running.

The 10-year German bund yield rose by six basis points relative to the 10-year Treasury yield last week to trade 202 bps below the U.S. government security's yield. Economic growth momentum continues to improve in the eurozone relative to the United States but French election dynamics were at play as well. Risk aversion ahead of Sunday's vote peaked on Monday. As stocks rallied throughout the week, German bund yields firmed up as well. The 10-year German bund yield also tested support at its 200-day moving average (0.17%), a key technical level.

The market expectation for five-year, five-year forward inflation fell by eight basis points to 2.09% as oil prices declined. Inflation expectations declined to their lowest level since the November 8 U.S. election as the familiar theme of fiscal stimulus delay keeps traders complacent about U.S. growth overshooting its potential. A $16 bln 5-year TIPS auction on Thursday was met with voracious demand, sporting the lowest primary dealer take-down ever.


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