As of 12-31-2017

While uncertainties about a major tax overhaul and a flattening yield curve were in the forefront during the fourth quarter of 2017, the U.S. economy and its central bank provided a positive underpinning for the markets. Temporary distortion of data due to major hurricanes that hit various parts of the U.S. in late summer gave way to data showing many aspects of the economy on an upward trend. Gross domestic product appeared to hover around the strong 3% growth track experienced in the second and third quarters,  a significant acceleration over the year-ago pace. The labor market continued to tighten, with unemployment falling and wages beginning to inch upward. Consumer spending was solid, with the combination of rising employment and robust confidence pushing holiday retail sales to three-year highs. Business sentiment and manufacturing activity also improved, while the housing market shed its summer lull with a boost of late-year activity.

Although the news was welcome, the policy actions announced by the Federal Reserve in the quarter were long in the making: the shrinking of its massive balance sheet of government and agency securities and another hike in interest rates. The reduction of its holdings began modestly, with $30 billion allowed to roll off of its books in the quarter, but will increase in size over the coming quarters. December’s increase of rates, the third move in the year, raised the target range to 1.25-1.50% and was accompanied by an optimistic outlook for the economy in 2018 and a projection for three additional hikes in the new year. But policymakers remained troubled by the lack of inflation and the flattening of the yield curve, the latter occurring as the difference in rates between the short and long end of the Treasury curve decreased over the quarter. The reporting period ended in a flurry of activity in the U.S. municipal bond market as issuers and investors reacted to various versions of GOP tax-reform proposals that could impact local and state governments as well as muni bond investors. President Trump signed the final bill into law in late December.

During the three months ended Dec. 31, 2017, the 1-month London interbank offered rate (Libor) rose from 1.23% to 1.56% and 3-month Libor rose from 1.33% to 1.69%. The short end of the U.S. Treasury curve also increased over the quarter, with 1-month and 3-month Treasury yields rising from 0.97% to 1.25% and 1.00% to 1.45%, respectively.

The 7-day SIFMA Municipal Swap Index began the fourth quarter at 0.94% and held that level until jumping in December to end the quarter at 1.71% on year-end excess supply of variable-rate demand notes (VRDNs) and Fed tightening. The 1-year MIG-1 yield leapt from 0.99% to 1.46% due to higher rates and continued flattening with the market building in a case for three Fed hikes in 2018.

Key Investment Team