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What happened last week?
This week’s U.S. inflation and labor market data painted a mixed picture for the Fed, ahead of this week’s FOMC meeting. August’s headline CPI rose 0.4% m/m, pushing the annual rate to 2.9%, slightly above expectations. Core CPI remained steady at 3.1% y/y, supported by volatile components like airfares and lodging. Before that, the producer price index (PPI) had come in softer than expected, but key service components—especially those feeding into the Fed’s preferred core PCE—suggest underlying price pressures remain firm. Meanwhile, initial jobless claims spiked to 263k, largely due to a temporary surge in Texas, but still suggest a cooling labor market.
Amid these mixed signals, markets are still pricing in three rate cuts in 2025, one 25bp at each of the three remaining meetings of the year (Wednesday this week, October 29th and December 10th). At the next meeting on 17.9, a 25bp rate cut now appears almost certain, but the evolution of domestic inflationary pressures will condition the decisions at the two meetings of the Q2 2025.
Last week, as expected, the ECB held its deposit rate steady at 2.00%, with President Lagarde emphasizing that policy is “in a good place.” Updated staff projections included a slight downgrade to 2027 inflation forecasts, but Lagarde downplayed the significance. Markets interpreted the tone as hawkish, with October rate cut expectations fading.
Future markets now assume that the ECB rate will likely remain stable for the coming months, with only a 15% chance of a 25bp rate cut by the end of this year and a 40% chance of a 25bp rate cut by the end of June 2026. Wage inflation and domestic demand pressures could even lead the ECB to consider a rate hike in the second half of next year.
USD credits delivered solid total return gains as lower rates and spread compression supported performance across ratings and maturities.
Fixed income shines. In 2025, central banks have delivered almost a hundred net rate cuts — the third-largest easing cycle on record — and attention now turns to the Fed, expected to cut at this week’s FOMC meeting.
While headlines focused on France’s fiscal strains and the Fitch downgrade to A+, demand for new EUR issuance remained strong. Both EUR Investment Grade and EUR High Yield deals were oversubscribed more than 3.5 times, underscoring resilient appetite.
The heavy September new bond issuance has been well absorbed, with spreads tightening across EUR and USD credits instead of widening as many feared.
The Vanguard USD Corporate Bond ETF was up +0.3% last week. The iShares Core Euro IG Corporate Bond ETF was flat as tighter credit spreads were offset by pressure from higher German bund.
USD High Yield had a positive week, while EUR High Yield was modestly down despite much tighter spreads.
Although credit spreads are at multiple year low, investors nevertheless see all-in-yields attractive, especially amid a healthy macro backdrop.
The USD yield curve was “twisted” last week by the combination of employment and inflation data that reinforced the case for Fed policy easing in the medium term but dampened expectations of accelerated rate cuts in the short-run. The front-end of the curve rose, as 2-year yields bounced off a 3-year low hit on Monday to end the week up +5bp to 3.56%. In the meantime, long term rates were lower last week, with the US Treasury 10-year down -1 bp to 4.06% and the 30-year down -8bp to 4.68%. Those movements were essentially driven by adjustments in real rate expectations, while inflation expectations were stable last week.
As a result, US Treasury ETFs were marginally down on medium maturities last week (iShares US Treasuries 3-7 year -0.1%) while longer maturity ETFs posted positive performances: the iShares US Treasury 7-10y was up +0.2%, the 10-20y equivalent rose by +0.9% and the 20y+ surged +1.6%. The iShares USD TIPY ETF was up +0.1%. Investors brace for this week’s FOMC meeting and update of economic projections and the dot plot.
In Europe, the neutral-to-hawkish tone of Ms Lagarde after the ECB monetary policy meeting pushed EUR rates higher across all maturities. The German 2 and 5-year yields were up +9bp, respectively to 2.02% (highest in five months) and 2.31%. The Bund 10-year was up +5bp to 2.72%, while most other European sovereigns recorded milder increases of their yields (Italy BTP 10y +2bp to 3.52%, Spanish Bono 10y +4bp to 3.29%). France was the exception as the expected resignation of the Bayrou government and the nomination of Sébastien Lecornu as Prime Minister doesn’t provide any more visibility on the French political outlook and chances of an improvement in public finances’ dynamic (OAT 10y +6bp to 3.51%). The iShares Core EUR Government Bonds ETF lost ground as a consequence last week (-0.1%). UK yields were also on the rise last week (UK Gilt 10y +3bp to 4.67%) and the iShares UK Domestic Government bon 3-7 years ETF lost -0.2%.
Emerging market
Emerging market (EM) credit spreads are now hovering near their tightest levels since 2007, yet EM debt funds continue to attract strong demand, posting a 21st consecutive week of inflows. As investors stretch further into risk assets in search of yield, volatility in EM corporate bonds has fallen below that of their developed-market peers.
EM corporate fundamentals are a key metric supporting EM valuations. Decreasing default rates to currently 1.5% provides a strong cushion to valuations.
Local-currency EM bonds led performance, with the JP Morgan EM Local Currency Bond ETF gaining +0.7%. In contrast, hard-currency products lagged: the iShares EM Sovereign Bond ETF slipped -0.5%, while the iShares EM Corporate Bond ETF managed a modest +0.1%. Asian high yield remained under pressure, with the iShares USD Asia High Yield Bond ETF down -0.3%.
In short, tight US credit spreads, solid EM fundamentals, and low default rates continue to anchor EM valuations. Still, softer U.S. growth and a potential slowdown in China remain key risks to watch.
