FIXED INCOME PERSPECTIVES

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1 MAY 2018 FIXED INCOME PERSPECTIVES Doug Drabik, Senior Strategist, Fixed Income Yield Curve v At first glimpse, it would appear that the month of May had little rate movement. Inside of two years, interest rates ended the month within 10 basis points* from the beginning of the month. The intermediate and long end of the Treasury curve moved only basis points. However, a deeper dive uncovers the month s significant volatility that was sparked largely by geopolitical events, making the flight to quality a prevalent trade. Treasury Yield Curve Yields (%) Duration 05/01/18 05/31/18 Change* 3 Month bp 6 Month bp 1 Year bp 2 Year bp 5 Year bp 7 Year bp 10 Year bp 30 Year bp *One basis point (bp) is equal to 1/100th of a percent. v The 10-year Treasury peaked with a 3.11% yield on May 17th. Many analysts saw the trend as the beginning of higher interest rates. What was exposed is that our markets can be affected by geopolitical events. The Italian crisis put much uncertainty into play. Within a day, that uncertainty moved the 10-year Treasury overnight close to -15 basis points for a price increase of 1.3 points. The chart on the following page demonstrates the variance of each yield curve point from its lows to its highs for the month of May. The 10-year Treasury moved nearly 3 points in price or 33 basis points in yield from its low to its high. After the month s biggest one day drop in yield, it retraced nearly half the yield it lost the next day. 1

2 Treasury High/Low May High Low Change Month May 3-May Month May 3-May U.S. 10 Year vs. 2 Year Treasury Spread Basis Points (bp) Year May 29-May Year Year Year Year Year Year Apr 5-May 10-May 15-May 20-May 25-May 30-May v Key developments bear mentioning: v Volatility is picking up. v Although the U.S. is clearly the world s leading economy, the bond market is impacted by the rest of the world. v Fundamentals still matter. The offsetting impact is another story. For example, employment data has consistently shown what is considered full employment. However, with no wage growth, results are stunted. v An overwhelming number of predictions have the Fed hiking rates early next month, but the aforementioned factors are making the likelihood of additional hikes in 2018 unclear. v The declining slope of the Treasury curve continues to be propelled by the Fed s insistence on hiking short term rates, while the long end of the curve is being held back by various factors (such as lack of inflation and a general global flight to quality). The net impact is less spread between the short and long end of the curve. 2

3 Market Opportunities World Bond Markets Yields (%) 2-Year 5-Year 10-Year 30-Year United States Canada France Germany Greece Ireland Italy Japan Netherlands Spain Sweden United Kingdom *One basis point (bp) is equal to 1/100th of a percent. v The current buzz has been about cash management. With the net uptick in interest rates, investors need to take notice. Sidelined cash can be portioned to short duration individual bonds, which meet most conservative risk parameters while significantly increasing income earned. The recently released Fixed Income Quarterly 2nd Quarter devotes an entire section to Tactical Cash Management. The bottom line is that there are options which provide an investor about basis points in additional yield versus typical money market rates. v As 2018 moves along, interest rates have inched up across the curve and corporate spreads have widened. Laddered investment strategies have been a viable method to mitigate interest rate risk while investing for income and principal protection. For years, some investors have been on the sidelines waiting for interest rates to hit particular milestones. One such milestone has been reached in the investment grade corporate space, where yields now enable investors to obtain a 4.00% yield in a 3-9 year ladder. Illustrated below are selected statistics from TradeWeb s Laddered Report. 3

4 v Municipal bonds continue to be a mainstay for investors that benefit from their tax advantaged characteristics. Investors in the highest tax brackets can earn strong tax-equivalent yields for the intermediate to long portion of their fixed income portfolio. The following statistics are derived from a sample laddered municipal bond portfolio comprised of maturities ranging from years and close to current coupons. Assuming an investor is currently in the highest federal tax bracket (37%), the tax equivalent yield is 5.29% with an average maturity of 15.5 years and duration of

5 Views expressed in this newsletter are the current opinion of the author, but not necessarily those of Raymond James & Associates or your financial advisor. The author's opinions are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Past performance is not indicative of future results. Diversification and strategic asset allocation do not ensure a profit or protect against a loss. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success. The information contained herein has been prepared from sources believed reliable but is not guaranteed by Raymond James & Associates, Inc. (RJA) and is not a complete summary or statement of all available data, nor is it to be construed as an offer to buy or sell any securities referred to herein. All prices and/or yields are indications for informational purposes only. Additional information is available upon request. Prior to transacting in any security, please discuss the suitability, potential returns, and associated risks of the transactions(s) with your Raymond James Financial Advisor. Investing involves risk and you may incur a profit or a loss. The value of fixed income securities fluctuates and investors may receive more or less than their original investments if sold prior to maturity. Bonds are subject to price change and availability. Investments in debt securities involve a variety of risks, including credit risk, interest rate risk, and liquidity risk. Investments in debt securities rated below investment grade (commonly referred to as "junk bonds") may be subject to greater levels of credit and liquidity risk than investments in investment grade securities. Investors who own fixed income securities should be aware of the relationship between interest rates and the price of those securities. As a general rule, the price of a bond moves inversely to changes in interest rates. While interest on municipal bonds is generally exempt from federal income tax, it may be subject to federal alternative minimum, or state or local taxes. In addition, certain municipal bonds (such as Build America Bonds) are issued without a federal tax exemption, which subjects the related interest income to federal income tax. Municipal bond investments may involve market risk if sold prior to maturity, credit risk and interest rate risk. CDs offer FDIC insurance and a fixed rate of return whereas both principal and yield of investment securities will fluctuate with changes in market conditions. CDs are insured by the Federal Deposit Insurance Corporation (FDIC), an independent agency of the United States government, for up to $250,000 per depositor. The coverage limit refers to the total of all deposits that an account holder(s) has at each FDIC insured bank. A credit rating of a security is not a recommendation to buy, sell or hold securities and may be subject to review, revisions, suspension, reduction or withdrawal at any time by the assigning rating agency. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise. U.S. Treasury bills are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. Treasury bills are certificates reflecting short-term obligations of the U.S. government. Diversification does not ensure a profit or protect against a loss. Investments are subject to market risk, including possible loss of principal. Prior to transacting in any security, please discuss the suitability, potential returns, and associated risks of the transactions(s) with your financial advisor. Duration is the measure of a bonds price sensitivity relative to interest rate fluctuations. Yield to Maturity (YTM): the total return anticipated on a bond if the bond is held until the end of its lifetime. Past performance is not indicative of future results Raymond James & Associates, Inc., member New York Stock Exchange/SIPC Raymond James Financial Services, Inc., member FINRA/SIPC. Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value. 5