Updated: 2017-07-25, 16:00:20 ET
The Interest Rate Outlook
U.S. Treasuries rallied for the second-straight week and the yield curve flattened as the European Central Bank voted to maintain its easing bias on Thursday. The ECB's EUR60 bln/month asset purchase program affects not only the yield curve of eurozone government debt but the Treasury yield curve too. The Governing Council reiterated that policy rates would stay at current levels "for an extended period of time, and well past the horizon of the net asset purchases." There had been some debate earlier this year about whether short-term rates might eventually be hiked before the conclusion of asset purchases. The market is now looking for an announcement about the future of the asset purchase program at the September meeting of the Governing Council. Analysts expect the ECB to taper the program in 2018 before eventually ending the asset purchases.
The U.S. economic data was limited but two regional manufacturing activity indices -- the Empire State and Philly Fed -- fell more than expected for July. Housing starts and building permits both beat forecasts in June but homebuilder sentiment weakened in July.
The S&P 500 gained 0.54% for the week to 2,472.5 while WTI crude fell 1.72% to $45.77/bbl.
|Fed Fund Futures Rate Prediction||December 2017 (47%)||December 2017 (53%)||NA|
|10yr Treasury - 2yr Treasury||88 bps||98 bps||-10 bps|
|High Yield - 10yr Treasury||372 bps||373 bps||-1 bp|
|Corp A - 10 yr Treasury||93 bps||93 bps||0 bps|
|10 yr Bund - 10 yr Treasury||-175 bps||-177 bps||2 bps|
|5yr, 5yr Forward Inflation Breakeven||1.89%||1.89%||0 bps|
The yield spread between the 10-yr Treasury note and the 2-yr Treasury note narrowed by ten basis points to 88 bps. The apparent commitment of policymakers at the European Central Bank to continue asset purchases kept a lid on longer-term yields.
The yield premium on high-yield debt fell by one basis point to 372 bps over Treasuries of comparable maturities. Continuing resilience to even modest corrections in the stock market and stabilizing energy prices helped keep appetites for high-yield debt strong.
Investment-grade spreads were steady at 93 bps over Treasuries with comparable maturities. The same factors supporting junk bond prices are also tailwinds for corporate bonds.
The 10-yr German bund yield rose two basis points relative to the 10-yr Treasury yield, ending at 175 basis points below the U.S. government security's yield. Despite a dovish ECB Governing Council statement and press conference with ECB President Draghi, the German yield moved higher relative to the U.S. yield. The eurozone recovery continues to broaden and deepen while the U.S. economy is running out of excess slack in the labor market. The first official estimate of Q2 U.S. GDP growth comes out on July 28.
Market expectations for five-year, five-year forward inflation remained at 1.89%.