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What happened last week?
Fed’s Caution, BoE’s Challenges, and ECB’s Easing Ahead!
As markets emerged from the holiday lull, the Federal Reserve resumed its cautious tone, further scaling back 2025 rate cut expectations. Minutes from the pivotal December 18th FOMC meeting revealed that the 25bp rate cut decision was "finely balanced," with several members considering a pause more prudent. Nearly all participants noted increased upside risks to inflation, emphasizing the need for caution in future monetary decisions. Recent economic data has bolstered this cautious stance. December's strong employment figures, robust service and manufacturing activity, and rising price pressures in ISM surveys suggest resilient growth and persistent inflation. Fed Governor Michelle Bowman echoed this sentiment, expressing concern that monetary policy might not be restrictive enough. She characterized the December rate cut as the final adjustment in policy recalibration, hinting at a potential pause in further easing. Futures markets reflected this shift, now pricing just one 25bp cut (-32bp) by summer 2025, down from two cuts (-40bp) earlier in the week. In the UK, fiscal vulnerabilities and inflationary pressures are creating headwinds for the Bank of England. Gilt yields climbed to their highest levels since 2008, and the GBP weakened to a one-year low against the USD. These developments complicate the BoE’s plans for further easing, with market-implied 2025 rate cuts reduced to -47bp from -60bp last week. The Eurozone faces contrasting dynamics, with continued weak economic data underscoring the need for monetary easing. With fiscal policy likely constrained—France grappling with EU and market pressures, and Germany bound by its debt brake until February’s elections—the ECB is expected to lead on stimulus. ECB Governor François Villeroy de Galhau advocated reaching a neutral rate of 2% by summer, aligning with the ECB's estimates. Market expectations for 2025 ECB rate cuts remain steady at -94bp, signaling anticipation of a measured yet impactful easing path.
A Record-Breaking Start Amid Volatility.
The credit market has kicked off 2025 with an extraordinary surge, as corporate borrowers capitalized on favorable conditions to secure funding at an unprecedented pace. A staggering $90 billion in investment-grade and high-yield dollar bond sales had been raised, marking the strongest start to a year since 1990. Key drivers of this record-breaking issuance include robust investor demand, economic uncertainty, and persistently narrow credit spreads, which continue to offer an attractive environment for debt issuance despite rising headwinds. Corporate issuers like BNP Paribas, Toyota, and Caterpillar have been swift to tap into the market, locking in favorable terms while investor appetite remains strong. This flurry of activity comes against a backdrop of $850 billion in maturing corporate debt this year, prompting many issuers to proactively address their refinancing needs. Despite this surge in supply, credit spreads have demonstrated resilience, remaining flat year-to-date for both investment-grade (IG) and high-yield (HY) bonds in the U.S. However, performance has been heavily influenced by duration: longer-duration instruments have borne the brunt of the sell-off seen in broader fixed income markets. In the U.S., the Vanguard USD Corporate Bond ETF (6.6-year duration) declined -1.2% year-to-date, reflecting the challenges posed by rising Treasury yields. Meanwhile, shorter-duration assets, like the iShares Broad USD High Yield Corporate Bond ETF (3.4-year duration), fared better, slipping just -0.2%. In Europe, corporate bonds followed a similar pattern, with the iShares Core Euro IG Corporate Bond ETF (4.3-year duration) down -0.8%, and the iShares Euro HY Corporate Bond ETF (2.3-year duration) easing -0.5%. Notably, European high yield saw slight spread widening, with the iTraxx Xover index increasing by +5bps, reflecting early signs of pressure in riskier credit segments. Subordinated debt also faced challenges, with increased supply hitting secondary markets. The WisdomTree AT1 CoCo Bond ETF dropped -0.7% since the start of the year, echoing broader market trends. However, some positive developments emerged: Fitch upgraded Banco de Sabadell to 'BBB+' with a stable outlook, citing a reassessment of the operating environment for Spanish banks, which contributed to a boost in sentiment for the sector. As 2025 unfolds, credit markets face a delicate balance between robust technical support and potential challenges from rising rates and macroeconomic uncertainty. For now, resilience remains the dominant theme.A Turbulent Start to 2025 as Yields Soar Amid Resilient Data and Inflation Fears.
The opening weeks of 2025 have brought severe challenges to government bond markets, driven by better-than-expected economic and inflation data, looming supply pressures, and fragile liquidity in certain markets, notably UK gilts. In the U.S., Treasury yields climbed sharply, with the 10-year yield surpassing 4.70% for the first time since 2023. Market sentiment now views the psychological 5% mark as a plausible near-term target, particularly after the 30-year yield briefly breached this level before closing at 4.95%. The Fed’s December minutes underscored the persistence of inflation risks, further diminishing expectations for rate cuts in 2025. Futures markets still price in one full cut for the year, but with U.S. economic data remaining robust, this expectation could evaporate, intensifying upward pressure on yields. Adding to the bearish tone, real yields are nearing cyclical highs, with the 10-year real yield at 2.35%, signaling an increasingly competitive environment for risk-free assets. Simultaneously, the U.S. Treasury term premium climbed to 0.6%, its highest since 2014, reflecting market concerns over inflation, fiscal imbalances, and shifting investor sentiment. Against this backdrop, U.S. Treasuries struggled, with the iShares USD Treasuries ETF down -0.9% year-to-date and the iShares 20+ Year Treasury Bond ETF falling over -2%. Across the Atlantic, turmoil in UK gilt markets stole the spotlight. The 10-year gilt yield surged to 4.92%, its highest level since the 2008 financial crisis. This spike was driven by a sell-off in bonds and sterling, signaling waning investor confidence in the Labour government’s fiscal strategy amidst rising borrowing costs. With the government facing soaring annual interest expenses of £100 billion, Chancellor Rachel Reeves confronts a narrowing fiscal window and difficult decisions ahead of the March budget. The iShares Core UK Gilts ETF reflected these pressures, falling -1.7% year-to-date. In the Eurozone, rising inflation further pressured bond markets. December’s year-over-year inflation accelerated to 2.4%, up from 2.2% in November, largely due to a rebound in energy prices. Core inflation held firm at 2.7%, with services inflation edging higher to 4%. This dynamic pushed the 10-year German Bund yield up 25bps to 2.60%, with key resistance at 2.70% in sight. Meanwhile, the 30-year French yield approached 4%, a pivotal threshold to monitor. In this environment, European government bond performance faltered, with the iShares Core EUR Govt Bond ETF down -1.4% since the year’s start. As markets adjust to resilient economic activity, sticky inflation, and persistent fiscal challenges, bond yields appear poised for continued volatility in the weeks ahead.
Emerging market
Resilience Amid Elevated US Rates and Global Uncertainty.
Emerging market (EM) bonds have shown remarkable resilience in early 2025, holding firm against the backdrop of high U.S. interest rates and a strengthening dollar. EM credit spreads have tightened further, reflecting robust demand and improving investor sentiment. EM corporate spreads compressed by 8bps to 205bps, while sovereign spreads narrowed by 10bps to 243bps, marking their lowest levels since 2013 and signaling the strongest point in this cycle. These movements underscore how EM economies are increasingly less tethered to the U.S. dollar, thanks to diversified financing sources and supportive macroeconomic conditions. Despite the positive spread tightening, performance across EM bond ETFs has been modest, driven by duration effects and rate pressure. The iShares Emerging Market Sovereign Bonds ETF is down -0.3% year-to-date, while the iShares Emerging Market Corporate Bonds ETF has slipped -0.2%. However, bright spots remain: Asian high-yield bonds have emerged as the standout performer, with the iShares USD Asia High Yield Bond ETF gaining +0.3% since the start of the year, underscoring robust demand in this high-growth region. The primary market has been equally dynamic, with issuers like Mexico, Chile, Codelco, and YPF tapping into long-term debt markets. These issuances, ranging between 10-year and 30-year maturities, highlight the proactive approach of EM borrowers to secure funding under favorable conditions. Looking ahead, 2025 presents both opportunities and challenges for EM markets. Elevated financing needs, stemming from high fiscal deficits and maturing debt, are estimated at nearly $160 billion, with a significant portion concentrated in the early part of the year. January alone accounts for 20% of these cash flows, with 50% expected within the first four months—a timeline likely influenced by tighter spreads and issuers' desire to get ahead of potential U.S. policy shifts. Nevertheless, global uncertainties, particularly surrounding U.S. economic policies and geopolitical risks, could temper investor enthusiasm as the year progresses. A more cautious and selective approach to EM investing may emerge, but for now, the strong technical backdrop and attractive spreads underscore the resilience and appeal of EM debt in 2025.
