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Rate Brief

Updated: 2016-02-10, 16:00:26 ET

The Interest Rate Outlook

The equity market endured another rough week that ended with a Friday selloff following a January Employment Situation Report, which missed on the headline (151,000; consensus 188,000), but showed better than expected hourly earnings growth (+0.5%; consensus 0.3%). Thanks to the above-consensus wage growth, the report was viewed as strong enough to leave the door open to another fed fund rate hike as early as March. 

Investors will be on the lookout for policy cues this week as Fed Chair Janet Yellen takes part in the semiannual monetary policy testimony before Congress on Wednesday and Thursday. Going into the testimony, the fed funds futures market has seen another shift with rate hike expectations being pushed out past February 2017.

Fed Fund Futures Rate PredictionAfter Feb. 2017Dec. 2016 (56.8%)---
10yr Treasury - 2yr Treasury112 bps118 bps-6 bps
High Yield - 10yr Treasury772 bps736 bps36 bps
Corp A - 10 yr Treasury162 bps152 bps10 bps
10 yr Bund - 10 yr Treasury-157 bps-161 bps4 bps
5yr, 5yr Forward Inflation Breakeven1.58%1.62%-4 bps

The January Employment Situation Report was the most noteworthy economic release delivered last week, but investors also received the January ISM Index (48.2; consensus 48.3), which ticked up from 48.0, but remained in contraction, and ISM Services for January, which fell to 53.5 from 55.8 (expected 55.0).

December Construction Spending (+0.1%; consensus 0.5%) missed estimates while December Income/Spending data showed a 0.3% increase in Personal Income ( consensus 0.2%), but Personal Spending and Core PCE Prices were unchanged.

The past week saw additional tightening in the spread between the 10-yr Treasury note and the 2-yr Treasury note. The spread slipped six basis point to 112 basis points, representing the lowest level since early 2008. This spread was at 131 basis points one year ago.

After narrowing two weeks ago, high-yield spreads widened notably once again into the end of last week. Crude oil surrendered its entire gain from the last week of January, leading to renewed concerns about highly-leveraged energy companies. This helped push the high yield-10-yr spread to 772 basis points, representing a 36-basis point increase. The spread returned near its January 20 high (784 bps) after trading near 484 basis points a year ago.

However, it wasn't just the high-yield spread that saw noteworthy widening as investment grade spread rose ten basis points to 162 basis points, checking in at its highest level since the middle of 2012, which suggests some underlying jitters about corporate balance sheets in the face of macroeconomic headwinds. For reference, this spread was at 113 basis points a year ago.


The spread between the German Bund and 10-yr note ticked up four basis points to -157 after holding unchanged during the previous week. Last week's move put the Bund-UST spread near the middle of this year's range (-150 to -166 bps), above last year's level of -149 basis points.

Inflation expectations returned to this year's downward trend after seeing a brief uptick two weeks ago. The five-year, five-year forward inflation breakeven rate decreased four basis points to 1.58%, which is comparable to levels seen in March 2009 and is below the 2.02% rate seen a year ago.