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What happened last week?
In the U.S., Fed Chicago President Austan Goolsbee praised the strong September jobs report but cautioned against reading too much into one month’s data. He noted that while the labor market remains robust, there are concerns that inflation could dip below the Fed’s 2% target. Goolsbee’s message? Let’s not get carried away with aggressive rate cuts just yet. Instead, he called for a steady approach that keeps both inflation and employment at favorable levels. This cautious tone reflects the broader strategy of not veering too far off the current path, as the Fed navigates the post-pandemic economy. On the other hand, former Treasury Secretary Larry Summers wasn’t so reserved. He slammed the Fed's recent 50 bps rate cut as premature, especially in light of the stronger-than-expected job growth. Summers argued that the Fed’s aggressive cuts might be misaligned with economic conditions, suggesting that a high neutral rate environment may require more careful and gradual monetary policy. The market, responding to these dynamics, has now adjusted its expectations, removing the chance of a full rate cut by year-end. Instead, the market outlook is aligned with the Fed’s own forecasts of two more rate cuts in 2024, reflecting a more tempered approach. Across the Atlantic, France’s central bank governor, François Villeroy de Galhau, offered a starkly different narrative. He confirmed that the ECB will "quite probably" cut rates at its upcoming meeting in October, with another cut likely in December. This dovish shift follows September inflation figures dipping below the ECB’s 2% target, with forecasts suggesting further declines toward that level by 2025. Villeroy signaled that the risk of inflation overshooting has now reversed to one of undershooting, advocating for flexible monetary policy to avoid prolonging restrictive measures. He downplayed concerns over rising oil prices, noting that unless they seep into core inflation, they should not influence the ECB’s policy stance. Meanwhile, the Bank of England Chief Economist Huw Pill urged caution in reducing rates too quickly, stressing that inflation risks could persist, especially with global uncertainties like rising oil prices driven by Middle Eastern tensions. His remarks reflected a more conservative view, suggesting that high interest rates may need to stay in place longer to combat inflation. Pill’s stance came just after Governor Andrew Bailey hinted at the possibility of more aggressive rate cuts, signaling that the BoE might have more room for maneuver if inflation continues to ease. Bailey’s more assertive tone rattled the markets briefly, increasing bets on further rate cuts this year.
September was a solid month for credit markets, with both the Vanguard USD Corporate Bond ETF and the iShares Broad USD High Yield Corporate Bond ETF gaining +1.5%. This performance was largely fueled by falling interest rates and a notable tightening in credit spreads. Investment-grade spreads narrowed by 4 basis points to 89 bps, while U.S. high-yield spreads tightened by 10 bps, reaching 295 bps. A standout was the CCC-rated bucket, representing the lowest-quality high-yield bonds, which saw spreads compress by a remarkable 120 bps to 642 bps. However, U.S. credit markets have struggled since the start of October due to a sharp rise in interest rates. The Vanguard USD Corporate Bond ETF dropped by 0.75% last week, and the iShares Broad USD High Yield Corporate Bond ETF fell by 0.2%. Despite this downturn in bond prices, credit spreads continued to tighten. U.S. investment-grade spreads hit 83 bps, marking their lowest level since 2021, while U.S. high-yield spreads contracted further to 284 bps, their tightest level since January 2022. In Europe, credit markets largely benefited from falling interest rates in September, with spreads staying mostly flat. Investment-grade spreads held steady at 117 bps, while European high-yield spreads narrowed by 3 bps to 357 bps. The iShares Core Euro IG Corporate Bond ETF and the iShares Euro HY Corporate Bond ETF performed well, rising +1.3% and +0.75% respectively. The subordinated debt segment also had a strong showing, with the WisdomTree AT1 CoCo Bond ETF gaining +1.4% and the Invesco Euro Corporate Hybrid ETF rising +1.5%. As October began, however, European credit markets calmed down, with all indices remaining relatively flat, reflecting some investor caution as they assess the potential impact of rising interest rates and economic uncertainties on credit markets going forward.
The beginning of October has been challenging for the government bond market, wiping out the strong performance seen in September. Last month, the iShares USD Treasuries ETF posted a solid gain of +1.2%, but those gains have been erased due to a sharp selloff in the front end of the U.S. Treasury yield curve. The 2-year U.S. Treasury yield surged nearly 40 basis points, ending the week at 3.92%, while the 10-year U.S. Treasury yield rose above 4%, a level not seen since the stock selloff in Japan back in August. This resulted in a notable flattening of the U.S. yield curve, which compressed to just 4 basis points, down from 19 basis points the previous week. Inflation expectations, as measured by breakeven rates, also ticked upward. The 10-year U.S. breakeven rate, an indicator of market expectations for inflation, climbed 10 basis points to 2.25%, while the 2-year breakeven jumped by 20 basis points. Meanwhile, the 10-year real yield, which accounts for inflation, rose 15 basis points, closing the week at 1.75%. This spike in yields has reignited volatility in the U.S. bond market, with the MOVE index—a key gauge of U.S. Treasury volatility—surging back above 100, reflecting heightened uncertainty. In Europe, September ended on a positive note for bondholders, with the iShares Core EUR Govt Bond ETF gaining +1.4%. However, the beginning of October was more subdued, with the ETF dipping by 0.3%. Eurozone inflation came in below 2%, and the Citi Eurozone Economic Surprise Index remained in negative territory, helping to limit the rise in interest rates. Peripheral bonds remained stable, with the spread between Italy and Germany’s 10-year yields tightening slightly to 129 basis points. Meanwhile, the spread between French and German 10-year bonds narrowed by 2 basis points to 77 bps, though it remains at its highest level since 2012. The outlook remains mixed as markets digest ongoing inflation data and macroeconomic shifts.
Emerging market
September ended on a positive note for Emerging Market (EM) bonds, especially within corporate bonds, where the iShares Emerging Market Corporate Bonds ETF gained +1.5%. This performance came despite EM corporate bond spreads remaining flat at 218 bps. Sovereign bonds performed even better, with the iShares Emerging Market Sovereign Bonds ETF posting a +2.0% return, driven by a 26 bps tightening in spreads, now down to 296 bps. EM local currency debt was another strong performer, posting a robust +3% gain, although currencies like the Mexican peso and Brazilian real also saw solid performance, bolstering returns. Notably, Chinese real estate bonds led the EM space, delivering an impressive +3.5% gain, supported by continued policy easing in China aimed at stabilizing the property sector. In monetary policy developments, Mexico's central bank cut its policy rate by 25 bps to 10.50%, marking its second consecutive rate reduction. Banxico struck a more dovish tone in its statement, signaling confidence in continued rate cuts as inflation eases and economic growth weakens. Meanwhile, Brazil's Central Bank took a different approach, raising the Selic rate to 10.75%, citing strong economic activity and labor market pressures. The Brazilian central bank (Copom) emphasized inflation risks and hinted at further tightening, with a 50 bps rate hike expected in November. Last week, EM bonds took a hit due to the sharp rise in U.S. interest rates. The iShares Emerging Market Corporate Bonds ETF lost -0.6%, while the iShares Emerging Market Sovereign Bonds ETF dropped -0.7%. Despite this, there was some positive news for Brazil, where Moody's upgraded the country's sovereign rating to BB+, opening the door for an investment-grade rating in the coming months. This has led to upgrades for several Brazilian corporates: Vale and Gerdau were both raised to BBB, and Suzano and Petrobras retained their ratings but with a positive outlook. These developments signal growing confidence in Brazil's creditworthiness, potentially boosting sentiment for EM debt in the near term.
