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What happened last week?
In a recent sequence of events that seems to reflect a shift toward easing monetary policies, voices from various central banks, including the Federal Reserve and the ECB, have been threading a narrative of caution intertwined with subtle optimism. Federal Reserve Chair Jerome Powell, addressing lawmakers just before the release of June's inflation data, painted a picture of a labor market losing steam, with unemployment ticking up for three consecutive months. His commentary emphasized the necessity of gathering more data to confirm that inflation is indeed on a decline toward the Fed's 2% target. Powell’s tone was one of prudence, suggesting that any hasty adjustments in interest rates could jeopardize the progress made on controlling inflation. The plot thickened as CPI data was released, showing encouraging signs of cooling inflation. Austan Goolsbee, President of the Federal Reserve Bank of Chicago, was quick to label the latest Consumer Price Index figures as “excellent.” The slowing of shelter inflation particularly caught his attention as a positive indicator that might lead to an interest rate reduction sooner rather than later. Despite this optimism, Goolsbee hinted he would not contest a decision to hold rates steady at the upcoming July meeting, portraying a stance of readiness yet restraint. Echoing this cautious optimism, Alberto Musalem from the St. Louis Fed acknowledged the CPI's nod towards the 2% inflation target as promising but stressed the importance of more robust evidence to ensure this trend is durable. This underscores a broader sentiment within the Fed: any decision to adjust policy needs to be well-supported by data, reflecting a balanced approach to the intertwined risks of inflation and economic growth. This narrative of cautious optimism has resonated across the Atlantic as well, where ECB officials are navigating similar waters. Joachim Nagel of the Bundesbank clarified that the ECB's future rate cuts are not a foregone conclusion but would depend on incoming economic data. Meanwhile, ECB Governing Council member Fabio Panetta discussed the peculiar nature of services inflation and its decoupling from goods inflation, suggesting that the current economic landscape still accommodates a gradual reduction in interest rates. Adding to this chorus, François Villeroy de Galhau from the Bank of France highlighted fiscal prudence amidst France's political flux, hinting at the delicate balancing act the ECB faces in steering monetary policy through uncertain times. As these narratives unfold, market anticipation has grown significantly, with expectations of a Fed rate cut in September rocketing to 95% following the CPI report, up from 56% earlier in the month. Similarly, the ECB is seen to possibly cut rates again in September, with the market pricing a strong probability of further easing by year-end.
This week in the credit markets, the rally in US Treasury bonds has significantly boosted the performance of corporate bonds. In the United States, while investment-grade (IG) corporate spreads held steady at 90bps, the Vanguard USD Corporate Bond ETF capitalized on the situation with a gain of +0.9%, leveraging its nearly 7-year duration. Although US high yield didn't fare as well in terms of performance—despite a 10bps spread tightening to 305bps—the iShares Broad USD High Yield Corporate Bond ETF still managed a solid +0.7% gain over the week. In Europe, the narrative was somewhat parallel, with IG corporate bonds riding the wave of robust European government bond performance, maintaining stable spreads over the week. This stability supported a +0.2% weekly rise in the iShares Core Euro IG Corporate bond ETF. The European high yield sector experienced notable movement: the iTraxx Xover index, which tracks the most liquid single CDS in European high yield, tightened by 15bps, reaching its lowest point since February 2022 at 282bps. However, the cash index told a different story, as the Bloomberg European high yield index saw spreads widen slightly by 5bps to 360bps. Despite this, the iShares Euro HY Corporate bond ETF posted a +0.4% increase for the week and maintains a +2% year-to-date gain. A significant development in the European high yield space was the upgrade of Telecom Italia by S&P by two notches to BB, following the completion of the sale of its national fixed-line access network to KKR in a deal valued at 22 billion euros. This transaction has buoyed market confidence in Telecom Italia's financial stability. Subordinated debt in Europe also saw impressive gains, with the WisdomTree AT1 CoCo Bond ETF and the Invesco Euro Corporate Hybrid ETF climbing +0.7% and +0.80% respectively over the week. These segments have delivered stellar performances year to date, with gains of +5.3% and +5.0%, marking them as some of the best performing European bond segments in 2024 so far. This week’s activities underscore a trend where the solid backbone provided by government bond performances has infused a dose of optimism across various credit markets.
In the US, the Treasury market is witnessing a fascinating narrative unfold as anticipation of a Federal Reserve rate cut grows stronger. The past week saw a nuanced dance of yields that continued to steepen the curve: the 2-year US Treasury yield declined by 15 basis points, while the 10-year yield eased by 8 basis points. This movement softened the curve’s inversion to -27 basis points, the gentlest since the outset of 2024, marking an intriguing chapter in the history of the US Treasury yield curve—which has been inverted now for a record two years. Amid these shifts, the MOVE index, which tracks interest rate volatility, dipped below 90 for the first time since May, signaling a calm settling over the market’s expectations of future volatility. This tranquility boosted the performance of treasury instruments, with the iShares USD Treasuries ETF gaining nearly 0.7% over the week, propelling its year-to-date total into the green. Additionally, the 10-year US Treasury real yield dipped under the 2% mark to close the week at 1.93%, its lowest since the early spring days of March. Across the Atlantic, the European bond markets resonated with a different tone, stirred by the aftermath of France’s legislative elections, which suggested a looming period of political gridlock. The yield spread drama continued with the 10-year Greek and French government bonds reaching a narrowing to just 30 basis points—a gap unseen since 2008. Meanwhile, the spread between the Italian and German ten-year bonds tightened to 129 basis points, mirroring near the narrowest spread of the year. This political and economic tableau painted a week of solid gains for European government bonds, with the iShares Core EUR Govt bond ETF up by 0.6%, although still trailing with a year-to-date decline of 1.2%. In Switzerland, the government bonds also experienced a week of gains, with an average increase of 0.5%, which bolstered their year-to-date rise to 1.2%. This performance underlines the enduring appeal of Swiss bonds amidst a backdrop of global uncertainty. Turning to Japan, the countdown to the Bank of Japan's upcoming policy meeting casts a shadow over the markets, with the 10-year yield holding above 1%—a level not seen since 2011. As the date draws nearer, the market holds its breath, waiting to see how Japan will navigate its monetary path amidst global and domestic pressures.
Emerging market
Emerging markets are having a notable week, buoyed significantly by the robust performance of US Treasury bonds. This ripple effect kept the spreads of the Bloomberg EM corporate bond index stable at 213bps, while EM sovereign spreads saw a tightening of 7bps to 322bps. The gains were impressive, with EM corporate bonds rising by +0.6% and the iShares Emerging Market Sovereign Bonds ETF climbing +0.8%. The week was particularly exceptional for EM local currency bonds, which surged by +1.8%, thanks to a depreciation in the US dollar prompted by a drop in short-term interest rates. For instance, a 10-year local currency Mexican government bond in US dollars boasted a rise of over 3%! Over in South Africa, the aftermath of the 2024 Presidential general election, which eased some political risks in the short term, has led to remarkable performance in government bonds—the JPM Govt Bond Unhedged USD South Africa is up by an astounding +15%! The debt markets were also buzzing with activity last week as Saudi oil giant Aramco made headlines with its first bond sale since 2021, issuing $6 billion. The offering was met with tremendous investor interest, amassing a book order nearing $30 billion. This move positions Aramco as the second-largest EM issuer with $24 billion of dollar bonds in circulation, trailing only behind Mexican state-owned oil company Pemex, which has $45 billion. In China, all eyes are on the upcoming Third Plenum, a critical policy meeting where the country's top leaders will deliberate on the path for structural reforms. Despite projecting a half-year growth rate around the 5% annual target, there's a palpable sense of concern that the Chinese economy might not have bottomed out yet. The plenum is expected to focus on advancing high-standard socialist market economy goals, with anticipations of bold policy actions and potentially increased government spending to revitalize the weakening consumer and business sentiment. Despite these significant discussions, the market anticipates no change in the PBOC 1-Yr Medium-Term Lending Facility Rate, which currently holds steady at 2.5%.
