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Bond Yields Rise as Market Focuses on Policy Announcement

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Bonds approach policy week cautiously

The Federal Open Market Committee (or FOMC) meets this week. Hence, bonds turned hypersensitive to any and all indications about a rate hike. Last week, bonds reacted negatively to New York Fed president William Dudley’s comments about a rate hike. China’s reduction in its reserve ratio also led yields to rise. However, weak economic pointers pulled yields down a bit.

Dudley viewed the US economy optimistically, and he was of the opinion that the FOMC will hike rates this year, warranted by the underlying strength in the economy.

Further, risk-on sentiment prevailed after China’s central bank reduced the reserve requirement ratio last week by 100 basis points to 18.5%—the largest reduction since 2008.

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Back home, weak economic indicators grabbed headlines and pulled bond yields lower. Orders for business equipment, which serve as a proxy for future corporate spending, fell in March, although overall durable goods orders rose by 4%. Further, a drop in new home sales by 11.4% in March led to mixed feelings about the housing market, especially since the home resales report had painted a better picture.

Meanwhile, major homebuilders reported their 1Q15 results. While PulteGroup’s (PHM) earnings missed Wall Street’s estimates, D.R. Horton (DHI) reported lower gross margins. The orders and the new home sales report pulled yields lower as participants viewed them negatively with respect to the possibility of an earlier rate hike.

Overall, yields rose, hurting investors in ETFs like the iShares Barclays 20+ Year Treasury Bond Fund (TLT), the iShares Barclays 7–10 Year Treasury Bond Fund (IEF), and the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD). Debt issued by companies such as Verizon (VZ), Goldman Sachs (GS), and General Electric (GE) are among LQD’s major holdings.

Yield movement

It was a whipsaw week for corporate bond yields, as seen by the BofA Merrill Lynch US Corporate Master Effective Yield. It rose one day and fell the next. Orders for business equipment, which were reported on April 24, helped yields fall, but they remained higher week-over-week.

In this series, we will take a detailed look at investment-grade corporate debt issuances for the week ending April 24. But first, let’s take a look at how yields on corporate bonds have fared in 2015 so far.

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