Fixed Income Quarterly Review
Fixed Income Quarterly Review, 06 / 2008
Chart 1: The Treasury Yield Curve
Concerns over a slowing economy and the ongoing credit crunch took a backseat to inflation concerns and thoughts of rising interest rates during the second quarter. Consequently, yields across the Treasury curve rose noticeably.
The 2-year Treasury yield rose 104 basis points, beginning the quarter yielding 1.58% and ending at 2.62%. The 10-year Treasury yield rose 56 basis points, starting the quarter at 3.41% and ending at 3.97%. The 30-year Treasury yield rose 23 basis points, starting the quarter at 4.29% and ending at 4.52%.
Chart 2: The Shape of the Yield Curve
The result of a resurgence in inflation concerns was a flattening of the yield curve. While all interest rates rose, short-term bond yields rose the most. The shape of the yield curve, measured by the yield spread between the 10-year and 2-year Treasury yields decreased by 48 basis points during the quarter. The Treasury curve began the quarter with 183 basis points between 10-year and 2-year yields and finished with 135.
The bond market selloff during the second quarter reflects the perception that the Federal Reserve may begin to raise rates as soon as the fall of 2008, sooner than consensus estimates three months earlier.
Chart 3: Corporate Bond Spreads
The yield spread on the Merrill Lynch Corporate Master index fell 26 basis point, beginning the quarter 300 basis points over Treasuries and ending 274 basis points over.
Bond spreads of finance companies, most sensitive to the current credit crisis, are very wide. The Merrill Lynch Corporate Finance Master index ended the quarter with a spread of 322 basis points over U.S. Treasuries.
Chart 4: Intermediate Term Bond Market Performance By Sector
A measure of risk acceptance, if not risk taking, entered the investment grade bond market during the second quarter. As yields rose and bond prices fell, there was a migration into higher yielding securities.
U.S. Treasury notes were the laggards during the quarter, though they still have the best performance of any sector over a trailing 12-month period. Mortgage-backed securities were the best performing sector in the investment grade arena for the quarter. Corporate bonds only modestly trailed the performance of the mortgage-backed market but have trailed other sectors by a good deal over a one year period.
Chart 5: Mortgage Lending Standards - Rising Sharply
Complicating the current situation surrounding credit concerns in the financial sector are the concerns regarding credit availability to individuals. The Federal Reserve conducts a survey of the banking industry quarterly to survey the landscape of the lending industry. The part of the survey regarding the net number of lending institutions tightening standards for mortgage lending has increased substantially. The current reading of 62 means that 81% of all lending institutions have tightened lending standards for mortgages.
This would certainly make it more difficult for all but the highest quality borrowers to secure good terms on a mortgage loan.
Chart 6: The Price Of Oil Per Barrel - West Texas Intermediate
A major factor weighing upon the U.S. consumer is the current spike in the price of energy. The price of a barrel of oil spiked to $140 per barrel at the end of the second quarter after beginning the period at a lofty $127. The price is up 99% over a period of one year and 369% in the past five years.
There are various theories surrounding this run up in energy prices ranging from emerging market demand and speculators to the rise in popularity of commodities as an investment asset class. No matter the cause, the effect has been quite predictable. The increased cost of driving and heating or cooling homes and offices creates quite a burden on American homes and businesses.
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