Economic Data: GDP/Inflation and Normalizing Rates Environment

The Department of Commerce revised GDP to 4.1% from 3.6% last week, driven primarily by an acceleration of private inventory investment and state and local government spending, as well as a deceleration of imports.  Inflation indicators were subdued last week, with unit labor costs coming in at negative 1.4%, which is well below its three-month moving average of 2.2%. CPI ex food and energy, another measure of inflation, met expectations at 1.7% but was below the Fed’s target rate of 2.0%.  Overall, inflation indicators remain subdued. The impact of more economic growth coupled with low inflation has the Federal Reserve slowly reducing its accommodative monetary policy but maintaining a near zero Fed Funds Rate.  With more clarity from the Fed on short-term rates, and a more confident consumer driving business activity, the two-year/ten-year yield curve relationship is steepening.  As the 10-year portion of the yield curve rises, we expect the front end to remain anchored over the next 12 months.  This steepening may hit the five-year and seven-year portions of the yield curve harder, as expectations for a Fed Funds rate hike grow beyond 2014.  We are protecting our clients from this scenario by under-weighting that segment of the curve in both taxable and tax-free strategies.