October 3, 2017

Continued moderate economic growth and the normalization of the Federal Reserve’s balance sheet are likely to exert upward pressure on Treasury yields in the fourth quarter.  Fed Chairman Janet Yellen has expressed her belief that the causes of low inflation are transitory and she has signaled that the Fed is likely to continue to raise short-term interest rates at a gradual pace even though inflation has remained below the Fed’s target of 2%.  Tax reform proposals are supportive of a modest boost to economic growth if passage is successful.  Some of the proposals include the elimination of interest expense deductibility for companies, which could reduce corporate bond issuance.  This dynamic, in addition to solid corporate profits, should lead to continued outperformance of corporate bonds versus similar duration Treasury bonds.  Given this outlook for higher absolute interest rates and a narrowing of corporate bond spreads, we continue to maintain a shorter duration position in our Clients’ bond portfolios versus the bond indices and to favor high quality corporate bonds.  While the municipal bond market has enjoyed solid returns year-to-date driven by strong inflows into the sector, returns may be muted going forward.  Municipal yields are likely to be pressured higher along with Treasury yields; and, if tax reform is passed, there may be reduced demand from individuals as the attractiveness of municipal yields may be diminished by lower tax rates.