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What happened last week?
Last week saw an ongoing debate within the Federal Reserve about the appropriate pace of rate cuts, with Governor Michelle Bowman advocating for a more cautious approach. She argued that the recent half-point cut was too aggressive, suggesting that a quarter-point reduction would have been more suitable given the gradual progress on inflation and solid economic conditions. Bowman emphasized that the neutral policy rate might be higher than pre-pandemic levels, hinting that monetary policy normalization could occur sooner than the markets anticipate. Her stance contrasts with the more dovish perspective of Federal Reserve Governor Adriana Kugler, who supported the half-point cut, noting that continued rate cuts might be necessary if inflation continues to decrease. Kugler pointed to signs of a cooling labor market, including slower hiring rates and fewer job quits, suggesting a shift toward more balanced employment conditions. She emphasized the need to maintain economic stability and remained open to further cuts depending on future data. Similarly, Federal Reserve Governor Lisa Cook endorsed the recent rate cut, highlighting its importance for sustaining a strong labor market while managing declining inflation. She stressed that the Fed's approach seeks to balance economic growth with the objective of bringing inflation back to the 2% target. These differing viewpoints within the Federal Reserve reflect the broader debate on how quickly the central bank should move with future rate cuts. Markets are currently pricing in nearly three rate cuts by the end of the year. In Europe, the Swiss National Bank (SNB) made its third consecutive quarter-point rate cut, signaling a notable dovish shift. The SNB also significantly lowered its inflation forecast, with expectations that it could fall as low as 0.5%. This has led markets to anticipate another rate cut in December, as the SNB seeks to manage the strength of the Swiss franc. Meanwhile, the European Central Bank (ECB) is also leaning toward potential rate cuts, possibly as early as October, as a result of disappointing PMI data and concerns over Germany's economic performance. Isabel Schnabel, a key member of the ECB's Executive Board, has taken a more dovish stance, aligning with projections for two 25-bps cuts before the year’s end.
The corporate bond market was subdued last week, with credit spreads seeing little movement. U.S. investment-grade (IG) spreads tightened by just 2 bps, closing below 90 bps for the first time since July, while high-yield (HY) spreads dropped below 300 bps. Despite stable spreads, the Vanguard USD Corporate Bond ETF posted a minor loss of -0.15%, while the iShares Broad USD High Yield Corporate Bond ETF eked out a modest gain of +0.1%. Issuance in the high-yield space was strong, driven by issuers taking advantage of the recent Fed cut. Last week alone saw over $8 billion in high-yield bonds issued, bringing the total for September to $34 billion—the highest level since September 2021. CCC-rated bonds were the top performers, delivering +0.5% for the week and bringing year-to-date returns to +12.5%. In Europe, credit markets benefited from the drop in interest rates, while spreads remained largely flat. Investment-grade spreads held at 117 bps, while high-yield spreads tightened by 8 bps, falling to 355 bps. The iShares Core Euro IG Corporate Bond ETF and the iShares Euro HY Corporate Bond ETF both gained +0.5% over the week. However, the high-yield space in Europe continues to feel the strain from sector-specific issues, particularly in the auto industry. Valeo, the global automotive supplier, was downgraded by Moody’s to BB+ as it faces a challenging market environment, characterized by volatile car production and weak consumer sentiment. Volkswagen and Stellantis also issued profit warnings, further dampening sentiment in the auto sector. Elsewhere, some profit-taking was observed in the bank bond segment, with the WisdomTree AT1 CoCo Bond ETF losing -0.6% last week.
U.S. government bond yields remained largely stable last week, with the 10-year U.S. Treasury yield closing at 3.75% and the 2-year yield at 3.55%. This slight steepening of the yield curve, now at 22 basis points, represents its highest level since June 2022. The short end of the curve was supported by better-than-expected inflation data. The Personal Consumption Expenditures (PCE) price index, a key measure of inflation, fell to 2.2%, its lowest level since February 2021, while the 6-month annualized rate dropped to 1.9%, the lowest since September 2020. Despite these favorable inflation trends, the U.S. Treasury market remained relatively flat, with the iShares USD Treasuries ETF unchanged for the week, and the iShares 10-20 Year Treasury Bond ETF slightly underperforming with a small loss of -0.2%. In Japan, government bonds experienced volatility as the 10-year Japanese yield briefly reached 0.8%, marking the first time it hit this level since the equity market sell-off in early August, before recovering to 0.85%. This movement followed Shigeru Ishiba’s win in Japan’s ruling party leadership election, setting him up to become the next prime minister. Ishiba has supported the central bank's slow departure from ultra-low interest rates, in contrast to his main rival, Takaichi, who advocated against further hikes. In Europe, French government bonds came under pressure following the appointment of the new French Prime Minister Michel Barnier. The spread between French and German 10-year yields widened to 80 bps, the largest gap since early August. In contrast, Greek 5-year yields dipped below those of France, signaling strength in Greek bonds. Meanwhile, German bonds posted solid gains, with the 10-year yield falling by 7 bps to 2.13%. Additionally, for the first time since November 2022, the German yield curve (2s10s) turned positive. In this environment, the iShares Core EUR Govt Bond ETF advanced by 0.5%, reflecting strength in core European bonds.
Emerging market
Emerging market (EM) bonds emerged as the standout performers last week, buoyed by strong inflows and positive developments in China. EM debt attracted $1.2 billion in inflows, marking the largest weekly inflow since January 2023. This influx of capital was reflected in the performance of the iShares Emerging Market Sovereign Bonds ETF, which benefited from a 16 basis point tightening in spreads, dipping below 300 bps for the first time since 2021. However, the higher duration of sovereign bonds slightly offset gains, resulting in a modest -0.15% loss for the ETF. In contrast, EM corporate bonds saw better results, with the iShares Emerging Market Corporate Bonds ETF advancing +0.3%. Meanwhile, local currency EM bonds continued their strong upward momentum, with the VanEck J.P. Morgan EM Local Currency Bond ETF rising +0.8%, pushing its year-to-date return to almost +5%. The strength in EM bonds was largely driven by China, where the iShares USD Asia High Yield Bond ETF surged nearly +1% following significant stimulus measures from the Chinese government. China’s stimulus package, aimed at reversing its economic slowdown, included substantial credit easing, a 50-bps cut to the reserve requirement ratio (RRR), and a reduction in short-term policy rates. These measures particularly boosted the struggling real estate sector, with additional policies to lower mortgage rates and reduce the minimum down payment ratio for second-home buyers from 25% to 15%. This stimulus propelled the Markit iBoxx USD China Real Estate High Yield Index by more than +5% last week, offering a much-needed recovery to the sector. Elsewhere in emerging markets, Turkey continued its record-breaking debt issuance streak, raising $3.5 billion through a long-term bond issuance. This latest offering brings Turkey’s total bond issuance for the year to a staggering $26.2 billion, marking a new annual record. The positive market sentiment towards Turkey’s debt suggests investor confidence in its ability to manage economic challenges while maintaining strong capital flows.
