Summary: 10-year treasury yields reached their highest point in almost four years, to close out the month at 2.72%, while 30-yr yields were up 21 bps to 2.72%. The yield on the policy-sensitive 2-year T-bills reached 2% for the first time since 2008. The sell-off was part of a wider trend across global sovereign debt markets as a resurgence of optimism regarding inflation - by month end the market was pricing a 99% chance for a March rate hike and a total of 2.64 hikes for the year. Looking at the economy, the picture remains strong overall with industrial production, consumer confidence and the purchasing managers' indexes (PMIs) up and unemployment rate remaining at a 17-year low. Core consumer price inflation (CPI) came in above expectations boosted by housing and medical costs.
FOMC Meeting: In its policy statement, the Fed subtly upgraded its outlook for inflation and said conditions would warrant "further" interest rate increases, suggesting that a policy rate hike at the March meeting is all but a inevitable conclusion. Overall the committee intends to keep going with normalization and was explicit on that point, but retained its "gradual" guidance. Effective February 3rd, with the new Fed Chair Jeromy Powell will assuming his post, as well as a new Vice Chair to be appointed, along with other Board seats, the composition of the FOMC at the end of the year will be meaningfully different than today.
Non-farm payrolls: December nonfarm payrolls gained 148K jobs, displaying an impressive string of positive employment numbers that has persisted for seven years now, as the U.S. economy continues to build momentum in employment that is virtually unprecedented over the past several decades. More positively, the unemployment rate remained 4.1% for a third consecutive month. Additionally, average hourly earnings increased by 2.5%.
Preliminary 4Q17 GDP: The US economy expanded at a weaker-than-expected 2.6% in the fourth quarter. The report showed an uptick of 3.8% in consumer spending and 3% in government spending, but the increase in trade deficit (imports increased at double the rate of exports) reduced gains in GDP.
December CPI: Headline CPI increased 0.1% (mom) in December, in line with expectations. Core CPI surprisingly rose 0.3% (mom), biggest gain since January 2017. This report brings headline inflation up to 2.1% (yoy) and core CPI inflation to 1.8% (yoy) and supports FOMC members' view that disinflation from 2017 will likely prove transitory.
Short Duration Portfolio Positioning: Given our view that front-end rates will be pressured higher, both the short and medium term portfolios are positioned short duration versus the benchmark. From a sector perspective the short-term fund is underweight Treasuries, neutral agency debentures and overweight corporates. It holds out-of-benchmark allocations to commercial paper, bank CD's, asset backed securities (ABS) and supranational paper. The Medium term fund is underweight Treasuries and overweight taxable municipals. Corporates, agency debentures and sovereign plus names. It holds out-of- benchmark allocations to ABS.
