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Curve Flattens into Year End

The final week of 2017 was a quiet one in U.S. bond markets, with yields edging slightly lower heading into an early close on Friday.  The short end of the curve ended the year materially higher versus year-end 2016 on the back of the Fed's monetary policy tightening while the long end treaded water and was flat for the year.  The two-year note is 70 bps higher than it was 12 months ago, while the ten-year note is within a few bps of where it began the year.  This flattening trend looks likely to continue in the absence of any significant increase in inflation. 

While the labor market continued to surprise to the upside this year, the lack of inflation has puzzled economists and has implications for monetary policy going forward.  Yields on the short end of the curve have priced in the likelihood of additional Fed funds rate increases, a policy move that seems dependent on the eventual emergence of some inflation (or atleast a good explanation for the current subdued readings.)

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