June 27, 2017 | Fixed Income Strategy

Fixed Income Weekly

Fixed Income Weekly Highlights

Treasury yields were mixed last week

o Lower on bills and notes & bonds on the long end of the curve
o Higher in the 1-7 year portion of the curve
Slope of the yield curve was flatter-down three bps to 80 bps
o Two-year note yield was two bps higher to 1.34%
o 10-year yield was down one bp to 2.14%
High yield spreads gapped out (+13 bps) and yields (+15 bps) were higher
o Concern over lower energy prices impact on the oil & gas sector

Second Quarter GDP forecasts:

o Atlanta Fed GDPNow Forecast is 2.9%
o New York Fed Nowcast Forecast is 1.9%
o Bloomberg Economist Survey is for growth of 3.0%
Range of forecasts is from 1.0%-to-3.6%

Economic Data:
o This Week is Fed Inflation week!
PCE Deflator - 1.5% in May down from 1.7% in April
PCE Core -1.4% in May down from 1.5% in April
o Next Week is Employment Report week!
Nonfarm payrolls forecast to increase by 173,000
Unemployment rate unchanged at 4.3%

Moodys LSI Updated

o Liquidity-Stress Index declines:
3.7 in mid-June
Down from the end of May 4.2%
o U.S. Speculative-Grade default rate forecast to fall to 2.7% by May 2018
Currently sits at 3.9%

Bond Market will close early at 2:00 EDT next Monday

th
It will remain closed for Independence Day on Tuesday the 4 .

B. Craig Elder, Director

Fixed Income Senior Analyst
celder@rwbaird.com
312-609-5433
 June 27, 2017 | Fixed Income

Fixed Income Comments

Yields on Treasuries remain low on the long end of the curve as yields on the short-end of the curve are rising. Traditionally,
short-term yield levels have been driven by the actions taken by the Federal Reserve via its fed funds target rate while long-
term yields have been driven by the markets future inflation expectations.

However, bond markets are not acting as they have traditionally many feel that is because of the massive Fed intervention
(justifiably so) that kept the economy from slipping into a depression late last decade by suppressing rates accomplished with
a zero bound fed funds target and massive balance sheet build of around $4.5 trillion of Treasury and MBS holdings.

However, this has resulted in low Treasury yields and caused credit sector spreads to narrow (and yields to fall) as investors
are forced to chase yield, i.e. take on more credit risk to receive yields that they need. Fixed income sector spreads remain
tight and with the exception of occasional misbehavior in high yield, there seems to be nothing happening economically or flow
wise (money continues to flow into fixed income as the world needs yield) to cause spreads to widen

However, is it possible that change is coming to the fixed income markets? The Fed seems hell bent on raising interest rates
not so much to fight inflation (still below their 2.0% target) but to normalize rates and to reduce the size of the balance sheet
holdings as soon as the fourth quarter of this year so that they will have the tools to deal with future economic activity
slowdowns. Expectations are that there could be another rate hike this year and possibly three or four more next year as they
move the fed funds target rate to the 3.00% level sometime in 2019 and reduce the size of the balance sheet to the $2.5-to-
$3.0 trillion level in the early 20s at the latest.

There are some who believe that these Feds actions will take interest rates higher and spreads will widen as investors dont
have to take on as much risk to get the yields they need later this year. Thats bad news for holders of existing debt, especially
longer-dated debt, but is a bit of good news for the yield seeking class. However, one must remember that the make-up of
the FOMC voters will likely change as three Fed governor slots are open and Chair Yellen & Vice Chair Fischers terms end in
the first half of 2018 and the levels of economic activity (to include inflation levels) could change any interest rate increase and
balance sheet reduction time table.

The yield on the benchmark 10-year Treasury finished the week at 2.14%, down one basis point while the yield on the two-
year note was two basis points (bps) higher at 1.34%, creating a slope of the yield curve as measured by the 2s/10s spread of
80 bps down three bps last week.

The short-end of the curve was lower with the yield on one-month bills down nine bps to 0.74% and three-month bills down five
bps at 0.95%. Three-month LIBOR continued to move higher finishing the week just under 1.30% (1.29328%) resulting in a
TED Spread of 34 bps (difference in 3-month LIBOR and 3-Month T-bill yields). The yield on the 30-year bond was six bps
lower at 2.72% (please see the Treasury yield curve from Bloomberg that follows).

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U.S. Treasury Yield Curve

Source: Bloomberg

Fixed Income Sector Spreads and Yields

The spread levels on fixed income sector issues were unchanged except with agencies which were two bps wider and high
yield at 15 bps wider. Yield levels were slightly changed with the exception of high yield where there was a 13 bps increase in
yields as falling energy prices rekindled fears of problems with high yield energy companies.

All fixed income sectors have positive total returns over the past 12-months with the exception of Treasuries which have a
negative 0.20% return. Best performance continues to be high yield, despite negative returns during the month of June, at
11.96%. Year-to-date all sectors have positive total returns led by high yield at 4.63% followed by investment-grade corporate
bonds with a total return of 4.43% and municipal bonds with a total return of 4.12%. Weakest performance has been in MBS
with a respectable total return of 1.80%, year-to-date.

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Fixed Income Sector Spreads

Sector 1/3/11 1/3/12 1/2/13 1/2/14 1/2/15 1/2/16 1/3/17 6/16/17 6/23/17
Aggregate 55 85 51 45 48 57 43 44 44
Agencies 27 52 27 37 51 50 54 46 48
MBS 42 69 45 34 28 26 15 33 33
Corporates 154 233 138 113 131 167 122 112 112
High Yield 515 682 493 382 488 674 398 365 378
Source: Bloomberg Barclays Indices

Fixed Income Sector Yields

Sector 1/3/11 1/3/12 1/2/13 1/2/14 1/2/15 1/4/16 1/3/17 6/16 6/16
Aggregate 3.01% 2.28% 1.79% 2.50% 2.23% 2.59% 2.63% 2.47% 2.46%
Treasuries 1.92% 1.08% 0.90% 1.45% 1.42% 1.72% 1.92% 1.81% 1.81%
Agencies 1.68% 1.26% 1.07% 1.69% 1.80% 2.04% 2.24% 2.13% 2.14%
MBS 3.70% 2.68% 2.27% 3.27% 2.56% 2.76% 2.87% 2.76% 2.76%
Municipals 3.83% 2.82% 2.19% 3.15% 2.07% 2.07% 2.65% 2.15% 2.16%
Municipals 5.85%* 4.34%* 3.63%** 5.22%** 3.43%** 3.43%** 4.46%** 3.62%** 3.64%**
Corporates 4.04% 3.80% 2.74% 3.26% 3.10% 3.68% 3.39% 3.13% 3.11%
High Yield 7.38% 8.14% 5.96% 5.62% 6.63% 8.87% 6.01% 5.50% 5.65%
Source: Bloomberg Barclays Indices
*Based on 35.0% top Federal Tax Rate
** Based on 39.6% top Federal Tax Rate

Fixed Income Sector Total Return and Statistical Data

TR-12 YTD Yield Spread Price Coupon Mat Duration Convexity
Aggregate 1.38% 2.86% 2.46% 44 $104.05 3.06% 8.24 5.98 0.09
Treasuries -0.20% 2.56% 1.81% n/a $102.47 2.09% 7.69 6.27 0.88
Agencies 1.45% 2.46% 2.14% 48 $102.71 2.54% 5.58 4.34 0.29
MBS 0.88% 1.80% 2.76% 33 $103.93 3.53% 6.81 4.44 (2.01)
IG Corporates 4.21% 4.43% 3.11% 112 $106.38 4.01% 10.97 7.55 1.09
Municipals 0.80% 4.12% 2.16% n/a $109.56 4.75% 12.95 6.19 (0.75)
High Yield 11.96% 4.63% 5.65% 378 $101.36 6.45% 6.30 3.88 (0.29)
Source: Bloomberg Barclays Indices

Economics
It was a light week for economic announcements with existing home sales surprising to the upside as forecasts were for
another decline in sales and new home sales were improved over the April numbers but fell short of economist expectations.

This week the focus will be on the inflation numbers that the Fed prefers the PCE deflator year-over-year with expectations
at 1.5% in May and the PCE core year-over-year at 1.4% during the same month. Investors will be examining the numbers as
any future interest rate increases should be dependent on expected future inflation.

The problem is that while the Fed expects inflation to rise to its 2.0% target level, the recent trends have been lower making it
harder to justify the rate hikes. While FOMC voters continue to make comments about another one-or-two rate hikes coming
this year (with the exception of Neel Kashkari President of the Minneapolis Fed), market indicators are that the Fed will not
raise rates until the March 2018 meeting at the earliest.

Since we will not publish next week, we have added a table with the economic releases for next week in this issue. The focus
for the fixed income market participants next week will be the employment report that will be out Friday morning. Expectations
are for an increase of 173,000 jobs during June with the unemployment rate unchanged at 4.3%
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Economic Releases Last Week

Economic Indicator Period Actual Survey Prior
Existing Home Sales May 5,620,000 5,550,000 5,560,000 (r-d)
Existing Home Sales (MoM) May 1.1% -0.4% -2.5% (r-u)
Initial Jobless Claims June 17 241,000 240,000 238,000 (r-u)
Leading Indicators May 0.3% 0.3% 0.2% (r-d)
New Home Sales May 610,000 590,000 593,000 (r-u)
New Home Sales (MoM) May 2.9% 3.7% -7.9% (r-u)
Source: Bloomberg
(r) revised u=upward / d=downward

Economic Releases This Week

Economic Indicator Day of Release Period Survey Prior
Wholesale Inventories Wednesday May P 0.2% -0.5%
GDP Thursday 1Q-Final 2.1% 2.1%
Initial Jobless Claims Thursday June 24 240,000 241,000
Personal Income Friday May 0.3% 0.4%
Personal Spending Friday May 0.1% 0.4%
PCE Deflator (YoY) Friday May 1.5% 1.7%
PCE Core (YoY) Friday May 1.4% 1.5%
Source: Bloomberg

Economic Releases Next Week

Economic Indicator Day of Release Period Survey Prior
ISM Manufacturing Monday June 55.0 54.9
Construction Spending (MoM) Monday May 0.1% -1.4%
Initial Jobless Claims Thursday July 1 n/a n/a
Nonfarm Payrolls Friday June 173,000 138,000
Unemployment Rate (BLS U-3) Friday June 4.3% 4.3%
Average Hourly Earnings (MoM) Friday June 0.3% 0.2%
Average Hourly Earnings (YoY) Friday June n/a 2.5%
Average Work Week Friday June 34.4 34.4
Labor Force Participation Rate Friday June n/a 62.7%
Underemployment Rate (BLS U-6) Friday June n/a 8.4%
Source: Bloomberg

Interest Rate Forecast

We recently added the interest rate forecast from the Bloomberg Survey of Economists to the Weekly (survey of several
economists 50+ done by Bloomberg). Forecasters seem to be adjusting their longer-term forecasts for longer maturity debt
lower and shorter-term interest rates slightly higher, compressing the slope of the yield curve further.

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Interest Rate Forecast from the Bloomberg Survey of Economists

Market Yield Q2 17 Q3 17 Q4 17 Q1 18 Q2 18 Q3 18
Fed Funds UB 1.25% 1.25% 1.40% 1.50% 1.65% 1.85% 2.00%
Fed Funds LB 1.00% 1.00% 1.13% 1.25% 1.41% 1.61% 1.78%
3-month LIBOR 1.29% 1.32% 1.51% 1.63% 1.80% 2.03% 2.21%
2-year T-Note 1.34% 1.42% 1.56% 1.72% 1.87% 2.06% 2.23%
10-year T-Note 2.14% 2.27% 2.52% 2.68% 2.78% 2.88% 3.04%
30-year T-Bond 2.72% 3.01% 3.17% 3.31% 3.40% 3.51% 3.61%
2s/10s Spread 80 85 96 96 91 82 80
Source: Bloomberg

Corporate Bond Market Comments

Investment-grade corporate bonds yields ended last week two bps lower at 3.11% while the spread level over comparable
Treasury yields was unchanged at 112 bps. High yield spreads ended the week 13 bps higher at 378 bps over comparable
Treasury yields (see spread chart from St. Louis Federal Reserve and Bank of America Merrill Lynch that follows) while the
yield level was 15 bps higher at 5.65%.

Investment-grade corporate bonds have a 4.21% total return on a trailing-12 month basis and 4.43% year-to-date, according to
data from Bloomberg Barclays Indices. High yield bonds have an 11.96% total return for the trailing 12-months and 5.65%
year-to-date, also according to data from Bloomberg Barclays Indices. Preferred stock has a 6.24% total return on a trailing-12
month basis and an 8.62% total return year-to-date while leveraged loans have a 7.95% total return over the past 12-months
and 2.58% year-to-date, according to data from Bank of America Merrill Lynch Indices.

Last week Moodys said that its Liquidity-Stress Index (LSI) fell to 3.7% in mid-June which was 50 bps lower from the end of
May. This is the lowest the LSI has been since November 2014 as Moodys indicated that it was the result of earnings gains,
including a recovery in some commodity sectors and favorable financing conditions as investors seek yield. The lower LSI
points to a lower U.S. speculative-grade default rate which Moodys forecasts to fall to 2.7% at the end of May 2018. This is
down from the current 3.9% default level.

S&P said that its trailing 12-month default rate dropped to 3.6% in May from 3.8% in April as there were six defaults in May.
Also, S&P indicated that speculative-grade downgrades spiked to 42, the highest level since November 2016 with downgrades
spread evenly among sectors with media and entertainment leading with only eight. There were 20 upgrades in May. .

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Historical Spread Levels for High Yield Bonds

Sources: BofA Merrill Lynch, BofA Merrill Lynch US High Yield Option-Adjusted Spread [BAMLH0A0HYM2], retrieved
from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BAMLH0A0HYM2, June 16, 2017.

Sources:
Atlanta Federal Reserve Bank. GDPNow. June 26, 2017.
BofA Merrill Lynch: BofA Merrill Lynch US High Yield Master II Option Adjusted Spread (retrieved from FRED
Federal Reserve Bank of St Louis. June 23, 2017.
Bloomberg: Bond News
Bloomberg Barclays Indices
CreditSights: Monday Meeting Notes Curve Keeps Flattening. June 26, 2017.
Moodys: SGL Monitor LSIs Fall Signals Growing Liquidity Strength. June 20, 2017.
New York Federal Reserve Bank. Nowcasting Report. June 23, 2017.
S&P: U.S. Speculative-Grade Monthly Downgrades Surged to a Six-Month High in May. June 26, 2017.

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Treasury Yield

Source: Bloomberg

For more information please contact your Financial Advisor.

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 Municipal Yield Curve

General Obligations - Yields as of 6/23/17

Time (Yrs) Year "AAA" Pre-re Insured "AA" "A" "BAA"
1 2018 0.83 0.83 0.94 0.86 1.03 1.30
2 2019 0.96 0.96 1.14 1.01 1.22 1.52
3 2020 1.04 1.04 1.25 1.11 1.35 1.67
4 2021 1.13 1.14 1.40 1.22 1.49 1.81
5 2022 1.24 1.25 1.54 1.34 1.63 1.94
10 2027 1.86 2.32 2.06 2.41 2.76
15 2032 2.31 2.79 2.55 2.88 3.24
20 2037 2.55 3.00 2.79 3.11 3.43
25 2042 2.63 3.08 2.87 3.19 3.51
30 2047 2.69 3.14 2.93 3.25 3.57

Muncipal Yield Curves (AAA, AA, A)

3.50
3.00
2.50
2.00
Yield

"AAA"
1.50
"AA"
1.00
"A"
0.50
0.00
1 2 3 4 5 10 15 20 25 30
Years

Please note that these levels are representative of institutional net levels, and do not
reflect retail sales credit.
These yields should be used as general market indicators only.

Source: Municipal Market Data

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 SUMMARY OF KEY FIXED INCOME MARKET INFORMATION

As Of 6/26/17

TODAY LAST WEEK MONTH AGO YEAR AGO

BOND BUYER REVENUE INDEX 3.70% 3.70% 3.92% 3.08%
BOND BUYER 20-BOND INDEX 3.53% 3.53% 3.73% 2.90%
BOND BUYER 11-BOND INDEX 3.04% 3.04% 3.24% 2.70%
REPRESENTATIVE MUNICIPAL BOND YIELDS
(Source: Bloomberg)
AAA RATED G.O.s 2 Year 0.90% 0.90% 0.91% 0.61%
5 Year 1.24% 1.24% 1.28% 0.92%
10 Year 1.84% 1.85% 1.95% 1.37%
30 Year 2.69% 2.72% 2.82% 2.18%
PRIME RATE 4.25% 4.25% 4.00% 3.50%
DISCOUNT RATE 1.75% 1.75% 1.50% 1.00%
FEDERAL FDS AVG 1.16% 1.19% 0.91% 0.40%
COMMERCIAL PAPER (PRIME) 30 Day na 1.16% na na
(Source: Bloomberg) 60 Day na 1.19% na na
90 Day na 1.24% na na

AGENCY DISCOUNT NOTES * 30 Day 1.37% 0.95% na na

60 Day 1.15% 0.99% na na
90 Day 0.93% 1.01% na na
TAXABLE 7-DAY FLOATER 1.00% 1.00% 1.17% 0.60%
(Source: Robert W. Baird & Co.)
TAX FREE 7-DAY FLOATER Non-AMT 0.81% 0.81% 1.06% 0.46%
(Source: Robert W. Baird & Co.) AMT 0.78% 0.78% 0.84% 0.68%
U.S. TREASURIES (% YTM) 3 Month 0.96% 1.00% 0.92% 0.25%
(Source: Bloomberg) 6 Month 1.10% 1.12% 1.07% 0.37%
1 year 1.20% 1.20% 1.15% 0.47%
2 Year 1.34% 1.36% 1.29% 0.63%
5 Year 1.75% 1.79% 1.79% 1.07%
10 Year 2.13% 2.19% 2.25% 1.56%
30 Year 2.69% 2.78% 2.91% 2.41%
CORPORATE A FINANCE YIELDS
(Source: Bloomberg) 2 Year 1.98% 1.97% 1.97% 1.56%
5 Year 2.58% 2.59% 2.66% 2.30%
10 Year 3.26% 3.28% 3.41% 3.14%
30 Year 4.02% 4.08% 4.24% 4.22%
CORPORATE A UTILITY YIELDS
(Source: Bloomberg) 2 Year 1.93% 1.93% 1.95% 1.44%
5 Year 2.51% 2.51% 2.60% 2.14%
10 Year 3.14% 3.17% 3.30% 2.91%
30 Year 3.88% 3.94% 4.12% 3.93%
CORPORATE A INDUSTRIAL YIELDS
(Source: Bloomberg) 2 Year 1.75% 1.73% 1.74% 1.19%
5 Year 2.31% 2.30% 2.39% 1.92%
10 Year 2.98% 3.00% 3.12% 2.76%
30 Year 3.79% 3.85% 4.03% 3.88%

CDs 1 Year 1.40% 0.80% 1.25% 0.80%

(Source: Robert W. Baird & Co.) 2 Year 1.65% 1.20% 1.65% 1.05%
5 Year 2.20% 1.75% 2.40% 1.55%
10 Year 2.60% 2.05% 2.75% 2.10%
* Yields presented represent the prevailing market price as of 6/26/2017 and are not representative of a specific issue.

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Appendix Important Disclosures

Some of the potential risks associated with fixed income investments include call risk, reinvestment
risk, default risk and inflation risk. Additionally, it is important that an investor is familiar with the inverse
relationship between a bonds price and its yield. Bond prices will fall as interest rates rise and vice
versa.

When considering a potential investment, investors should compare the credit qualities of available
bond issues before they invest. The two most recognized rating agencies that assign credit ratings to
bond issuers are Moody's Investors Service (Moodys) and Standard & Poor's Corporation (S&P).
Moodys lowest investment-grade rating for a bond is Baa3 and S&Ps lowest investment-grade rating
for a bond is BBB-.

This is not a complete analysis of every material fact regarding any sector, municipality or security. The
opinions expressed here reflect our judgment at this date and are subject to change. The information
has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. It is
strongly recommended that an investor discuss with their financial professional all materially important
information such as risks, ratings and tax implications prior to making an investment. Past performance
is not a guarantee of future results.

This report does not provide recipients with information or advice that is sufficient on which to base an
investment decision. This report does not take into account the specific investment objectives, financial
situation, or need of any particular client and may not be suitable for all types of investors. Recipients
should consider the contents of this report as a single factor in making an investment decision.
Additional fundamental and other analyses would be required to make an investment decision about
any individual security identified in this report.

ADDITIONAL INFORMATION ON SECURITIES MENTIONED HEREIN IS AVAILABLE UPON

REQUEST BY CONTACTING YOUR BAIRD INVESTMENT PROFESSIONAL.

Copyright 2017 Robert W. Baird & Co. Incorporated.