Feb 1 2016 - Rate Brief
The equity market endured a shaky start to the previous week, but stocks were able to finish the week and the month on an upbeat note thanks to a broad-based rally on Friday, which took place after the Bank of Japan implemented negative interest rates on some excess reserves held at the central bank. The news weighed on the yen, boosted the dollar, and served as yet another reminder of the persistent divergence among the major central banks.
Domestically, investors received the January policy statement from the Federal Reserve, which acknowledged the presence of macroeconomic headwinds, but still left the possibility of four rate hikes in 2016 on the table. Once again, the Fed reiterated its belief that the decline in oil prices is transitory even though WTI crude had surrendered nearly 20.0% between policy meetings in December and January.
The unchanged outlook at the Federal Reserve did not stop the market from pushing back its rate hike expectations as fed fund futures now project the Fed will not hike the fed funds target rate until December.
|Fed Fund Futures Rate Prediction||Dec. 2016 (56.8%)||Jun. 2016 (50.7%)||---|
|10yr Treasury - 2yr Treasury||118 bps||119 bps||-1 bps|
|High Yield - 10yr Treasury||736 bps||746 bps||-10 bps|
|Corp A - 10 yr Treasury||152 bps||149 bps||3 bps|
|10 yr Bund - 10 yr Treasury||-161 bps||-161 bps||0 bps|
|5yr, 5yr Forward Inflation Breakeven||1.62%||1.54%||8 bps|
The past week was relatively quiet on the economic front, but investors did receive the advance reading of fourth quarter GDP.
The advance fourth quarter GDP report hit an annualized rate of real GDP growth of 0.7% while the Briefing.com consensus expected a reading of 0.9%. Every major component showed weakness on a quarter-over-quarter basis with personal expenditures increasing 2.2% after rising 3.0% in the third quarter.
Separately, New Home Sales (544K, Briefing.com consensus 506K) beat estimates in December while December durable goods orders fell 5.1% (Briefing.com consensus -0.5%). Durable orders excluding transportation also disappointed as the related index fell 1.2% (Briefing.com consensus -0.1%). Just about every area disappointed with transportation equipment orders falling 12.4%, machinery orders dropping 5.6%, and nondefense capital goods orders sliding 4.3%. Shipments of nondefense capital goods declined 0.2% in December after falling 1.1% in November and 1.0% in October. The durable orders report provided a negative input for the advance Q4 GDP reading.
The past week saw minimal movement in the spread between the 10-yr Treasury note and the 2-yr Treasury note. The spread slipped just one basis point to 118 basis points, hovering eight basis points below its level from a year ago (126 bps).
High-yield spreads narrowed after starting the year with a notable widening. Last week's narrowing occurred amid a relief rally in crude oil, which climbed to $34.82/bbl after testing the $26.00/bbl level two weeks ago. Crude oil advanced amid speculation regarding plans for an emergency OPEC meeting, but there was nothing concrete on that front.
With the rebound in crude prices and the better market tone at the end of the week, the high-yield spread came down to 736 basis points as of Friday. The investment grade spread, meanwhile, bumped up three basis points for the week to 152 basis points.
At the same time a year ago, the high-yield spread and the investment grade spread stood at 512 basis points and 115 basis points, respectively.
The spread between the German Bund and 10-yr note held unchanged after widening by ten basis points to 161 basis points two weeks ago. Bunds and Treasuries advanced in unison after the Bank of Japan's decision to implement negative rates reduced the yield on the 10-yr Japanese Government Bond to just 0.114% on Friday from Thursday's 0.226%.
Inflation expectations increased during the past week after diving through the first three weeks of 2016. The five-year, five-year forward inflation breakeven rate increased eight basis points to 1.62%, which remains comparable to levels seen in March 2009 and is below the 1.93% rate seen a year ago.