Fixed Income Quarterly Review
Fixed Income Quarterly Review, 09 / 2006
Chart 1: The Treasury Yield Curve
A softening housing market combined with weaker employment data led to a rally in the bond market during the third quarter. Bonds maturing two years and beyond fell in yield from 40 to 50 basis points.
The 2-year Treasury note fell 47 basis points during the quarter to 4.68%. The 5-year note fell 52 basis points to 4.57% and currently is the lowest yielding point on the yield curve. The 10-year Treasury note fell 51 basis points to end the quarter yielding 4.62%.
Chart 2: Residential Real Estate, Rising Inventories
Over the last 6 months, rising interest rates began to impact the residential real estate market. Low interest rates that had been in place since 2003 created a willing market for new and existing homes. As mortgage rates rose, supply began to outpace demand.
As of August 2006, the months supply of residential housing inventory stood at 7.5 months. This is the highest reading since the National Association of Realtors began tracking the data in 1999.
Chart 3: Commercial Construction, Solid Growth
Concerns over the excess capacity of residential construction are being felt while commercial construction continues to increase. In August 2006, non-residential commercial construction increased at an annual, seasonally-adjusted rate of $80.95 billion. This is an increase of 17.1% over August 2005. The increase in commercial construction may help to fill in the gaps created by a slowdown in residential housing.
Chart 4: The Shape of the Yield Curve
The shape of the yield curve, as measured by the yield differential between the 2-year Treasury note and the 10-year Treasury note, remained slightly inverted. At the end of the quarter the 10-year note yield was 6 basis points below that of the 2-year note
A negative yield curve is viewed with caution by market participants as it has historically been associated with a slowing economy.
Chart 5: Corporate Bond Spreads
Corporate bond spreads tightened slightly during the quarter. The spread on 5-year A-rated corporate bonds tightened 3 basis points ending the quarter 72 basis points above Treasuries. The general widening of corporate bond spreads beginning in March 2005 may still be in place.
Chart 6: Intermediate Term Bond Market Performance By Sector
Much of the bond market's performance over the past 12-months occurred in the third-quarter of 2006. With interest rates falling 40 to 50 basis points across the yield curve, most of the return came from rising bond prices.
Mortgage-backed securities posted the largest return for the quarter with a 3.8% total return followed by investment-grade corporate bonds which posted a 3.7% return. Government securities, U.S. Treasury and agency notes, performed in-line with each other at 2.9% for the quarter.
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