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Strong Employment Growth Forces Market to Accept That Fed Will Begin to Raise Rates This Summer

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U.S. Treasury bonds fell precipitously Friday as the strong employment report finally forced the market to accept that the Fed will most likely begin to raise short-term rates this summer. The nonfarm payroll report indicated that employment grew by 295,000 in February, easily surpassing the consensus estimate of 230,000, and the unemployment rate fell to 5.5%. With employment growing strongly and unemployment now at the top of the Federal Reserve's estimated range of central tendency, it's increasingly difficult for the Fed to make the case that the federal funds rate should still be zero. The current zero interest rate policy, put in place in December 2008, was originally intended as an emergency measure to support the entire financial system during the financial crisis, which would normalize soon thereafter. While headline inflation will decline in the short term as lower oil prices flow through the economy, inflation excluding energy continues to run near 1.5%, not that much lower than the Fed's 2% target.

The yields on 5-, 10-, and 30-year Treasury bonds rose 20-24 basis points last week, with more than half the increase in yield occurring Friday. Credit spreads tightened at the beginning of the week and then traded in a relatively narrow range for the remainder of the week. The average spread of the Morningstar Corporate Bond Index tightened 6 basis points to +127 and the average spread of the Bank of America Merrill Lynch High Yield Master Index tightened 4 basis points to +442.

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David Sekera does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.