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Rate Brief

Updated: 2016-10-20, 16:00:19 ET

The Interest Rate Outlook

Last week saw renewed volatility in the major U.S. equity indices as U.S. Treasury yields moved higher again and the U.S. dollar gained added to its October rally. The S&P 500 lost 1.1% for the week and was down 1.7% for the fourth quarter.

The most significant U.S. economic release last week was September retail sales on Friday, which came out in line with analyst expectations. Headline retail sales grew by 0.6% m/m, in line with the consensus, while retail sales ex-auto rose 0.5% m/m, also in line with the consensus. The producer price indices for September, both headline and core, both grew more than expected during September (0.3% m/m and 0.2% m/m, respectively). Faster-than-expected inflation should shorten the time until the second Fed rate hike of this tightening cycle.  

Fed Fund Futures Rate PredictionDec. 2016 (69.2%)Dec. 2016 (70.2%)---
10yr Treasury - 2yr Treasury96 bps90 bps6 bps
High Yield - 10yr Treasury467 bps477 bps-10 bps
Corp A- 10 yr Treasury112 bps116 bps -4 bps
10 yr Bund - 10 yr Treasury-179 bps-176 bps-3 bps
5yr, 5yr Forward Inflation Breakeven1.81%1.76%5 bps

The spread between the 10-yr Treasury note and the 2-yr Treasury note widened by 6 basis points to 96 bps. The spread is now within an easy day's trade of a five-month high. As a rate hike at the December 13-14 FOMC meeting has become a greater certainty following some encouraging if uninspiring data this fall, the 2s/10s spread has been widening.

High-yield spreads declined by 10 basis points, continuing the narrowing trend of the past three weeks. Oil prices that continue to drift higher as well as interest rates that remain historically low are helping to support junk bond prices. This economic environment is close to ideal for high-yield debt as corporate profits muddle along just enough to keep defaults low while not spurring rate hikes that would push investors out of fixed-income assets.

Investment-grade corporate debt yields narrowed again this week in relation to risk-free government bonds. The Merrill Lynch Corporate 'A-Rated' Index narrowed by four basis points to 112 bps.

The 10-year German bund yield narrowed by three basis points versus the 10-year Treasury yield. The spread now stands at -179 bps as the European Central Bank is expected to keep its deposit rate at -0.40% for some time longer. The European Central Bank's governing council meets on October 20. 

Five-year, five-year forward inflation expectations rose by five basis points to 1.81%, a five-month high. This rate is a market-based measure of inflation expectations that is closely followed by central banks. The steady rise of this metric will encourage Fed policymakers in light of a decline in the Michigan Consumer survey's long-term inflation expectations to an all-time low in October