.png)
What happened last week?
The Federal Reserve approaches its final meeting of 2024 on December 18th with a high likelihood of another 25bp rate cut. Following Friday's employment report, which depicted a resilient but not overheated job market, market-implied probabilities for a December cut surged to 90%. Earlier in the week, Fed Governor Christopher Waller signaled support for easing, emphasizing that monetary policy remains restrictive and that further cuts would not fundamentally alter its stance. However, Waller, like many of his colleagues, stressed the importance of incoming data, leaving the door open to pausing if inflation surprises to the upside. Mary Daly reinforced the case for continued easing but noted that the neutral rate might have risen, potentially closer to 3%. Austan Goolsbee forecasted significant rate reductions in the medium term, while Raphael Bostic highlighted the need for flexibility. The collective tone from Fed officials suggests cautious optimism, though the looming specter of inflationary pressures from tariffs in 2025 underscores the complexity of their decisions. In Europe, the ECB’s December 12th meeting is expected to deliver a 25bp rate cut, but the probability of a larger 50bp move has virtually disappeared, now priced at just 7%. The shift follows softer inflation expectations, political instability in France, and Bundesbank President Joachim Nagel’s warning against acting "too hastily." These factors suggest the ECB will favor a gradual approach as it navigates a fragile growth environment. Meanwhile, the Swiss National Bank faces its own balancing act. With inflation well-contained and the franc’s safe-haven appeal bolstered by European instability, the SNB is under pressure to counter excessive CHF appreciation. While markets assign a 41% probability to a 50bp rate cut, expectations for a preemptive move have slightly declined. As the year draws to a close, central banks on both sides of the Atlantic face contrasting challenges. The Fed grapples with robust U.S. growth and inflationary risks, while the ECB and SNB contend with slowing economies and currency dynamics. These divergent paths will shape the trajectory of monetary policy into 2025.
The U.S. bond market delivered another week of positive returns as Treasury yields edged lower, particularly at the shorter end of the curve. This decline was driven by a pullback in real rates, with inflation expectations remaining stable. Long-term bonds continued to lead performance, benefiting from their higher sensitivity to rate movements. The iShares 10-20 Year Treasury Bond ETF rose +0.9%, while the iShares 3-7 Year Treasury Bond ETF gained +0.3% and the iShares 1-3 Year Treasury Bond ETF edged up +0.2%, with returns primarily reflecting carry. Treasury Inflation-Protected Securities (TIPS) also posted gains, with the iShares TIPS Bond ETF up +0.4%, supported by the drop in real yields. In Europe, a more complex dynamic unfolded. Rising inflationary expectations from the latest ECB survey contrasted with easing concerns over France's political instability, producing a nuanced market response. German yields inched higher, reflecting a slight retreat in safe-haven demand, while sovereign spreads across the periphery narrowed. Italian, Spanish, Portuguese, and even French yields declined, with Italy’s 10-year yield hitting its lowest point since August 2022. French 10-year yields briefly traded above their Greek equivalents, highlighting concerns over political turbulence and the lack of progress on fiscal reforms in Europe’s second-largest economy. Against this backdrop, European government bond performance was mixed. The iShares EUR Government Bond 10-15 Years ETF rose a modest +0.4%, while the iShares EUR Government Bond 3-7 Years ETF remained flat over the week. Inflation-linked securities saw marginal gains, with the iShares EUR Inflation-Linked Government Bond ETF up +0.1%. The divergence between U.S. and European markets reflects the different pressures at play: resilient U.S. growth and inflation concerns on one side, and Europe’s political and fiscal uncertainties paired with subdued growth prospects on the other. These contrasts are likely to persist as markets look toward year-end central bank meetings for further guidance.
Emerging market
Emerging market (EM) debt delivered another week of positive performance, reflecting steady momentum in the asset class. Growth prospects across EMs remain robust, with improving economic activity expected to sustain the recovery into 2025. While fiscal deficits in EM countries are substantial, public and external debt levels are significantly lower than in developed markets, offering relative stability. However, with EM high-yield (HY) valuations appearing stretched, the credit spread differential between EM investment-grade (IG) and HY could widen over the coming year as markets adjust to richer HY valuations. The Bloomberg Emerging Markets Hard Currency Aggregate Index rose +0.6% for the week, supported by sovereign debt performance. In contrast, corporate debt faced challenges, with the iShares Emerging Market Corporate Bonds ETF declining -0.4%. Local currency bonds continued their positive trajectory, with the VanEck J.P. Morgan EM Local Currency Bond ETF gaining +0.4%, bolstered by improving EM currency sentiment and easing global rate pressures. Political developments dominated headlines in specific EM regions. In Romania, the Constitutional Court stunned markets by annulling the results of the first round of the presidential election held on November 24. Official intelligence reports uncovered Russian interference in the campaign of far-right, pro-Putin frontrunner Calin Georgescu, who had garnered 23% of the vote. Romanian government bonds reacted positively to the annulment, as the potential election of a pro-Putin president had raised concerns about political instability and economic risks. Meanwhile, in South Korea, the temporary imposition of martial law did not affect the country’s credit ratings, but it highlighted underlying political volatility. This could pose downside risks to GDP growth in the coming months, as uncertainty impacts consumer and business confidence. While EM debt maintains its resilience, diverging regional dynamics and evolving political landscapes highlight the importance of selective positioning. As the credit spread differential between EM IG and HY narrows, a revaluation of risks and opportunities across EM markets is likely to define the next phase of investor strategies.
