Fixed Income Quarterly Review
Fixed Income Quarterly Review, 03 / 2006
Chart 1: The Treasury Yield Curve
Interest rates rose during the first quarter across all maturities. Since the Federal Reserve began raising interest rates in 2004, short-term interest rates have moved up while long-term interest rates moved down. This was termed by former Federal Reserve Chairman Greenspan a "conundrum". Long-term rates began rising in earnest during the quarter.
Two-year Treasury note yields rose 0.41% during the quarter from 4.40% to 4.81%. Five-year Treasury notes rose 0.46% during the quarter from 4.35% to 4.81%. Ten-year Treasury notes rose 0.45% during the quarter from 4.39% to 4.84%.
Chart 2: Oil and Gold
The bull market for commodities marches on. Two commodities, oil and gold, figure prominently in the markets assessment of future growth and inflation.
The price of a barrel of oil has remained largely north of $60 since July 2005. During the first-quarter, the per barrel price moved up $5 from $61 to $66.
The price of gold on a per ounce basis is reaching levels not seen since the early 1980s. During the first-quarter, the price of gold moved up $66 from $517 to $583. Gold has historically been seen as an inflation hedge.
Chart 3: Personal Consumption Expenditure, The Fed’s Inflation
Maintained by the Bureau of Economic Analysis, the Personal Consumption Expenditure (PCE) is the preferred inflation measure of the Federal Reserve.
After reaching a low of just under 1.0% in the summer of 1998, the trend for headline PCE has been upward and sits at 2.9% as of February 2006, the most recent published reading.
The more stable core PCE reading, which excludes the volatile food and energy components has been moving up as well though more slowly and sits near the high end of Chairman Bernanke's comfort zone of 1.0% to 2.0%. A persistent rise in core PCE could keep the Fed active in raising interest rates.
Chart 4: The Flattening of the Yield Curve
Short-term interest rates spent much of the first-quarter yielding more than long term interest rates. At the end of February a 10-year Treasury note could be purchased with a yield of 4.55% while a 2-year Treasury note had a yield of 4.67%. This is what the market has come to refer to as an inverted curve. By the end of the first quarter the inversion was no more as the yield of a 10-year note was 0.02% more than a 2-year note.
Inverted yield curves are uncommon and have historically preceded slowdowns in economic activity.
Chart 5: Corporate Bond Spreads
Investment grade corporate bond spreads tightened modestly during the quarter from 0.91% over Treasury notes at the end of 2005 to 0.89% over Treasury notes at the end of the first-quarter.
Notably, in spite of 15 rate hikes totaling 3.75%, corporate bond spreads are tighter than when the Federal reserve began moving interest rates up in June 2004. The strength of the corporate sector and the economy in general has shown a great deal of resilience in the face of tightening monetary policy.
Chart 6: Intermediate Term Bond Market Performance By Sector
Debt of U.S. agencies performed the best during the quarter followed by mortgage-backed securities. U.S. Treasury debt narrowly outpaced corporate debt as interest rates rose across all maturities during the quarter.
Over the trailing 12-month period, mortgage-backed securities were followed closely by U.S. agency debt as the best performing sector in the investment grade market.
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