Fixed Income Quarterly Review
Fixed Income Quarterly Review, 03 / 2007
Chart 1: The Treasury Yield Curve
The U.S. Treasury yield curve fell across most maturities during the quarter as expectations for slower economic growth brought yields down, largely in shorter maturities.
The 2-year Treasury yield fell 23 basis points, beginning the quarter yielding 4.80% and ending at 4.57%. The 10-year Treasury yield fell 6 basis points, starting the quarter at 4.70% and ending at 4.64%. The 30-year Treasury yield managed to rise a modest 3 basis points, starting the quarter at 4.81% and ending at 4.84%.
Chart 2: The Shape of the Yield Curve
Short maturities fell more in yield than long maturities resulting in a steepening in the shape of the U.S. Treasury yield curve during the quarter. This was significant as the yield spread between 2-year Treasury yields and 10-year Treasury yields went from negative to positive.
Many view a negatively sloped yield curve as a precursor to sub-par economic growth, so the move from negative to positive could be an encouraging sign.
Chart 3: Corporate Bond Spreads
The yield of investment-grade corporate bonds over Treasuries widened somewhat during the quarter. As measured by the Merrill Lynch Corporate Master index, yield spreads widened by 4 basis points to end the quarter 95 basis points over Treasuries.
AA-rated bonds widened 8 basis points, beginning the quarter 61 basis points over Treasuries and ending 69 basis points over. A-rated bonds widened 3 basis points, beginning the quarter 84 basis points over Treasuries and ending 87 basis points over. BBB-rated bonds remained unchanged, beginning and ending the quarter 122 basis points over Treasuries.
Chart 4: Intermediate Term Bond Market Performance By Sector
The decline in interest rates over the quarter bolstered the performance of intermediate bonds. Intermediate Treasury bonds returned 1.6% for the quarter with 1.2% coming from coupon income and 0.4% coming from price appreciation. Corporate bonds were the best performing investment-grade sector, up 1.8% while mortgage-backed and agency bonds lagged modestly.
Chart 5: ISM Manufacturing, New Orders Index
One forward looking indicator of economic activity is the New Orders sub-index of the Institute for Supply Management's Manufacturing index. This national index compares the current months with the prior months new orders.
The index stood at 51.6 at the end of the quarter, down slightly from 51.9 at the beginning of the quarter. Since an index reading above 50 indicates an expansion in new orders, the current level of activity is viewed as a positive for the near-term manufacturing sector of the economy. The trend in the index since 2004 shows a gradual cooling in new order activity. This is worth monitoring and could be a cause for concern should the index fall below 50.
Chart 6: Long-Term Inflation Expectations
The market's perception of future inflation rose during the quarter. Long-term inflation expectations as measured by the yield difference between a U.S. Treasury Inflation Protected security (TIP) and a comparable U.S. Treasury note rose during the quarter.
The inflation expectations increased from 2.52% at the beginning of the quarter to 2.61% at the end of the quarter. Since 2003, inflation expectations have ranged between 2.50% and 3.00%, but the long-term trend has been upward. This is a concern for the Federal Reserve who have been vocal about their desire not to see inflation expectations rise.
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