Market Review

After four rate hikes, beginning in December 2015, the federal funds rate stands at a range of 1.00% to 1.25%. The September FOMC meetings concluded with no change to rates. However, the hawkish tone delivered by the Fed through its “dot plots” showed continued support for a third rate hike in 2017 by 12 of the 16 FOMC members. This sent the implied probability of another rate hike this year up to 70%, from a low of 30% at the end of August. 

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Although the economic data were mixed, the theme for the month was ultimately stable growth but weak inflation. Retail sales, consumer confidence, and GDP all were positive; housing releases disappointed. Corporate earnings topped 10% for the second consecutive quarter. Most importantly, inflation has clearly remained below market expectations as well as the Federal Reserve’s 2% target.

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During the month, Fed Chair Yellen provided the semiannual testimony to Congress, which appeared to align with recent meeting minutes. The takeaways indicated an inclination to begin allowing the Fed’s balance sheet to decline in a gradual manner starting in late September or October. As a result, no change in interest rates is expected in September, with December being data and market dependent. 

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The Federal Reserve has reemerged front and center in the debate over interest rates. While the Fed never takes a backseat in the minds of bond investors, the preeminence of Fed activity had been overshadowed by the fiscal policy implications of the new Administration’s tax cutting and infrastructure spending plans. Fed policy makers moved forward with another rate increase, the second this year and the fourth in the current tightening cycle, along with an outline for the potential tapering of bond purchases.

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Treasury yields declined modestly during the month and the yield curve flattened, a continuation of trends seen for most of 2017. Ten-year yields initially rose to 2.41% early in the month, before falling to 2.23% at monthend. The 2- to 30- yield curve spread has declined by 30 basis points since the beginning of the year.

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Disappointing economic data and concern over the impact of the French presidential election weighed on the market, leading investors to buy bonds and push rates modestly lower. Treasury yields fell from two years and out, with the 10-year portion being the biggest beneficiary, flattening the yield curve.

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