Fixed Income Quarterly Review
Fixed Income Quarterly Review, 3 / 2010
Chart 1: The Treasury Yield Curve
U.S. Treasury interest rates ended the first quarter very nearly where they began. The shortest and the longest maturities saw their yields rise modestly while most maturities in between saw a slight drop in their yields.
The 2-year Treasury yield fell 12 basis points, beginning the quarter yielding 1.14% and ending at 1.02%. The 10-year Treasury yield fell 1 basis point, starting the quarter at 3.84% and ending at 3.83%. The 30-year Treasury yield rose 7 basis points, starting the quarter at 4.64% and ending at 4.71%.
Chart 2: The Shape of the Yield Curve
The yield difference between 10-year U.S. Treasury rates and 2-year U.S. Treasury rates rose during the quarter from 269 basis points at the end of December to 280 basis points at the end of March. This is historically a very steep yield curve.
The bond market responds to monetary stimulus by the central bank (the Federal Reserve) by steepening the yield curve. This is done as bond market participants price in a combination rising inflation and increased economic activity.
Chart 3: Corporate Bond Spreads
Corporate bond risk, as measured by the yield spread of the Merrill Lynch Corporate Master index, improved during the quarter. Beginning the quarter 190 basis points above the Treasury market, corporate yield spreads tightened to finish the quarter 161 basis points above Treasuries.
Since the beginning of this yield spread series in 1996, the narrowest yield spread was 54 basis points in September 1997. The widest yield spread was 641 in November 2008. The median yield spread from 1996 through the end of the first quarter 2010 has been 119 basis points. Corporate yield spreads, therefore, are still higher than historically normal.
Chart 4: Intermediate Term Bond Market Performance By Sector
Spread tightening in the corporate bond market allowed that sector to outperform during the first quarter. Mortgage-backed securities performance followed in second place among investment grade sectors and government securities were the worst performers.
Over the trailing 12 month period, corporate bonds far and away were the best performers, government bonds were the worst performers and mortgage-backed securities performed well.
Chart 5: Jobless Claims
An encouraging and very important corner of the economy is the jobs market. One indicator of the health of the jobs market comes out every Thursday morning. It is the number of people applying for first-time unemployment benefits. Since peaking in March 2009, the claims number has moved down sharply. This is a positive, early sign that the economy is on the mend.
The jobless claims are not to be mistaken for a measure of the unemployment rate. As the jobless claims point toward improvement in the employment situation, new people entering the jobs market can actually serve to elevate the unemployment rate. This can serve to mask the signs of early economic recovery.
Chart 6: 5-Year Credit Default Swap
One area of concern, within a global economic context, is the deterioration in sovereign credits. At the forefront of this trend is the country of Greece. Credit default swaps are financial instruments that allow investors to buy protection against an entity defaulting on their debt. It is a form of insurance and as such, goes up in value as the likelihood of default increases. Greece's default swaps, which were valued at 5 as recently as June 2007, touched a high of 399 in January 2010. This is a troublesome trend as Greece is not alone when it comes to high levels of sovereign debt. Countries such as Spain, Italy and Ireland also have a great deal of debt to service. The ability of these countries to service their public debt load will be a very important factor in the velocity and magnitude of any meaningful global economic recovery.
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