July 5, 2017

Treasury yields on longer maturity bonds are likely to rise in the third quarter as recent curve flattening appears to be overdone.  While yields on short-term maturity bonds have risen year-to-date, longer dated Treasury bond yields have come down, likely due to inflation data coming in weaker than expected and recent oil price weakness.  As economies around the world continue to post moderate growth, we believe the Federal Reserve will continue to normalize policy and will begin reducing the size of its balance sheet in the second half of 2017, which should put upward pressure on interest rates.  While corporate bonds have continued to outperform, resulting in low bond spreads, we believe these levels can be maintained given low absolute yields, improved corporate earnings and cash flows, and continued synchronized global growth.  Accordingly, we continue to maintain a duration in our Clients’ bond portfolios that is approximately 10-15% shorter than the indices and favor high quality intermediate corporate bonds.  The municipal bond market, driven by strong demand, has outperformed the taxable market.  This has resulted in a depressed yield level relative to Treasury bonds, with the ratio of a Aaa-rated 10-year General Obligation municipal bond yield to a 10-year Treasury yield declining to 84%.  The quality of the sector is strong, supported by continued growth in state and local tax collections and we believe the likelihood of changes to the deductibility of tax-exempt interest through tax reform is low.  Thus, while the attractiveness of the sector relative to taxable bonds has decreased, investors in high tax brackets are still able to benefit from purchasing municipal bonds on a taxable equivalent basis.