Interest Rates Surge Higher; Curve Steepens

The bond and equity markets last week continued to follow the same trend since the election. U.S. Treasury bonds fell, pushing interest rates substantially higher, and the S&P 500 rose 0.81% to 2,181.90. After having fallen as low as 1,810 in February, the S&P 500 is now only about 12 points away from making a new all-time high. In the bond market, the entire yield curve rose and continued to steepen as long-term interest rates rose faster than short-term rates. For example, the yield on the 2-year Treasury rose 15 basis points to 1.07%, whereas the yield on the 10-year Treasury surged 20 basis points to 2.35%. These levels represent the highest level that interest rates have traded, as well as the steepest level that interest rates have been, thus far this year. With the stock market rising and inflation expectations at their highest levels since the fall of 2015, the markets are fully pricing in an interest rate hike by the Federal Reserve in December. According to data from CME Group, the market-implied probability that the Fed will increase the federal funds rate after the Dec. 14 Federal Open Market Committee meeting rose to over 95% at the end of last Friday.

Through Nov. 17, the average spread of the Morningstar Corporate Bond Index widened 2 basis points to +136 while the Bank of America Merrill Lynch High Yield Master Index tightened 12 basis points to +485. Although corporate credit spreads tightened in the junk bond market, investors continued to pull money out of the high-yield space for the third consecutive week. Open-end mutual funds and exchange-traded funds suffered from withdrawals last week, with the total amount of redemptions equaling $1.3 billion.

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