Fixed Income Quarterly Review
Fixed Income Quarterly Review, 06 / 2007
Chart 1: The Treasury Yield Curve
Interest rates rose across intermediate and long maturities as the bond market removed a series of interest rate cuts anticipated to be delivered by the Fed in 2007 and 2008.
The 2-year Treasury yield rose 29 basis points, beginning the quarter yielding 4.57% and ending at 4.86%. The 10-year Treasury yield rose 38 basis points, starting the quarter at 4.64% and ending at 5.02%. The 30-year Treasury yield rose 28 basis points, starting the quarter at 4.84% and ending at 5.12%.
Chart 2: The Shape of the Yield Curve
The shape of the yield curve as measured by the number of basis points between the 2-year and 10-year Treasury yields increased during the second quarter. The Treasury curve began the quarter with 6 basis points between 2-year yields and 10-year yields and finished with 16.
As a measure of the future state of the economy, a positively sloped yield curve is viewed more favorably than a negatively sloped one. While a positive yield curve could indicate an increase in future inflation or growth, a negatively sloped curve is seen as an indication of restrictive monetary policy and potential economic weakness ahead.
Chart 3: Corporate Bond Spreads
Corporate bond spreads widened during the second quarter. The additional yield offered for holding investment-grade corporate bonds over U.S. Treasury notes increased from 95 basis point at the end of the first quarter to 100 basis point at the end of the second quarter. This is the widest yield spread for investment grade corporate bonds since April 2005 when yield spreads jumped to 102 basis points on concerns over downgrades for U.S. automakers by the major rating agencies.
Chart 4: Intermediate Term Bond Market Performance By Sector
Credit concerns and a re-assessment of risk premiums led to general spread widening during the quarter. This and rising Treasury yields led to flat to moderately negative returns during the quarter.
During the second quarter, U.S. agency bonds posted the best return while corporate bonds performed the worst. For the trailing 12-month period, corporate bonds posted the best returns followed by mortgage-backed securities.
Chart 5: Quarterly Junk Bond Issuance
The issuance of below investment grade debt continued at an impressive pace in the second quarter as $57.8 billion in new junk bond issuance came to market. The junk bond issuance in the second quarter was only eclipsed by the fourth quarter of 2006 which saw $59.2 billion brought to market.
The low level of junk bond spreads over Treasury yields has encouraged much deal making in this market. Loose lending standards have led very low credit quality companies to issue debt that, in more restrictive times, would not have had access to the capital markets. This type of issuance is usually a precursor to rising corporate default rates within an 18 to 36 month period.
Chart 6: Existing Home Sales
The condition of the residential real estate market has received a great deal of attention. Concerns persist that the slowdown in housing activity will negatively impact the economy at large.
Sales of existing homes proceeded at a 5.99 million units per year pace in May. This is well below the September 2005 peak of 7.21 million units and above the 5.0 to 5.5 million pace which were commonplace in the late 1990s. Until this data shows signs of stabilization, the housing market will continue to weigh upon the concerns of the market.
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