.png)
What happened last week?
In light of recent disappointing U.S. economic data, Federal Reserve Governor Christopher Waller has made it clear that the time has come for the Fed to begin cutting interest rates this month. Waller pointed to growing risks in the labor market and the potential for further weakening, indicating that the Fed may need to act swiftly. He remains open to a more substantial rate cut if necessary, emphasizing that immediate action is more critical than patience, particularly after the release of weaker-than-expected jobs data. His comments suggest that the focus is on supporting employment, without raising alarms about an impending recession. Meanwhile, San Francisco Fed President Mary Daly also reinforced the need for rate cuts, stressing that maintaining a healthy labor market is the Fed’s top priority. She pointed out that overly tight monetary policy risks further slowing down the labor market, which would be an undesirable outcome. Daly advocates for a responsive approach to policy adjustments based on incoming data, with the goal of fostering continued labor market strength and economic expansion. Despite these calls for action, the market remains cautious about the scale of the Fed's next move. There’s currently less than a 25% chance priced in for a 50-bps rate cut at the upcoming September FOMC meeting, but the outlook beyond that meeting is more aggressive. Investors are bracing for at least two "jumbo" 50-bps rate cuts in subsequent meetings. In Europe, ECB Governing Council member Martins Kazaks hinted at possible rate cuts in September, pointing to the substantial progress made in reducing inflation since mid-2021. Although service sector costs remain high due to wage increases, Kazaks suggested the ECB will need to carefully weigh the pace and magnitude of easing. Markets are split on whether the ECB will deliver a rate cut at each remaining meeting in 2024 or only one more reduction in December. Interestingly, two events seem under the market’s radar: the low likelihood of a Bank of Japan rate hike and the minimal expectation for a Bank of England rate cut in September. Either outcome could catch the market off guard if realized.
The credit markets had a mixed week, with investment-grade (IG) bonds outperforming the high-yield (HY) segment. The Vanguard USD Corporate Bond ETF rose 1.1%, although IG credit spreads widened by 5 bps to 98 bps, driven primarily by a surge in new debt issuances. Last week, we witnessed one of the busiest issuance periods in recent memory, with companies rushing to take advantage of lower borrowing costs ahead of the upcoming U.S. presidential election. On Tuesday alone, 29 companies issued new debt, contributing to a record $82 billion of high-grade bonds being sold across the week, the busiest since May 2020. This issuance volume weighed on spreads but didn’t detract from overall performance, thanks to favorable rate movements. High-yield credit didn’t fare as well, with spreads widening by 17 bps to 322 bps, resulting in a modest gain of 0.1% for the USD High Yield Corporate Bond ETF. This widening highlights ongoing concerns about economic softness, despite a strong performance from the rates side of the equation. In Europe, the theme was similar, with high-quality credit outperforming lower-rated bonds. European IG spreads were stable at 118 bps, while high-yield spreads widened by 18 bps to 378 bps. The iShares Core EUR Corporate Bond ETF gained 0.5% over the week, while the iShares EUR High Yield Corporate Bond ETF fell by 0.2%. Subordinated debt provided a mixed bag of returns, with the WisdomTree AT1 CoCo Bond ETF up 0.1%, while the Invesco Euro Corporate Hybrid ETF remained largely flat. The AT1 bond market saw strong issuance activity, hitting a weekly record of EUR 7.1 billion, featuring deals from names like UBS, HSBC, and BNP Paribas. Globally, bond values climbed 0.3% to $69.29 trillion, edging closer to an all-time high.
One of last week’s key takeaways is the end of the longest U.S. Treasury yield curve inversion in history. The 2-year U.S. Treasury yield dropped by 25 basis points in just four business days, hitting 3.63%, its lowest level since September 2022. While this sharp re-steepening of the curve (+50bps in less than 3 months) may initially seem positive, history tells us that a rapid reversal following an extended inversion often signals an approaching recession. Whether this time will be different remains to be seen. In this context, U.S. government bonds posted solid gains, with the iShares USD Treasuries ETF climbing over 1% during the week. The 10-year U.S. Treasury yield also hit a one-year low of 3.65%. The rally was further supported by a sharp drop in oil prices, with crude erasing its 2024 gains to hit its lowest level since June 2023. This bull steepening trend favored longer maturities, with the iShares 10-20 Year Treasury Bond ETF gaining over 2%, while the iShares 3-7 Year Treasury Bond ETF rose by 1.0%. However, U.S. Treasury Inflation-Protected Securities (TIPS) underperformed slightly, with the iShares USD TIPS ETF posting a modest 0.3% gain. The 5-year U.S. breakeven rate tumbled to 1.89%, its lowest level since December 2020, while the 10-year breakeven rate hovered near 2%. In Europe, bond performance was more contained. The iShares Core EUR Govt Bond ETF gained nearly 1%, but German yields remain higher than they were at the start of the year, with the 10-year yield reaching 2.15%, compared to 2.02% in January. Peripheral spreads widened slightly, with the difference between Italian and German 10-year yields increasing by 5 basis points to 145 bps. In France, the spread over German yields tightened following the official appointment of Michel Barnier as the new French Prime Minister. Meanwhile, the 10-year Swiss government yield remained flat around 0.5%. Lastly, Japan's 10-year government yield, which had risen to a one-month high, finally ended the week 5 bps lower at 0.85%.
Emerging market
Emerging market (EM) bonds posted modest gains last week, benefiting from lower U.S. interest rates. The iShares Emerging Market Corporate Bonds ETF closed the week up 0.1%, though EM corporate spreads widened by 18 bps to 236 bps, marking the third consecutive month of spread decompression. This slow widening has seen spreads rise from 208 bps at the end of May, reflecting growing risk aversion among investors. On the sovereign side, the iShares Emerging Market Sovereign Bonds ETF gained 0.2%, with spreads remaining unchanged at 320 bps. The best performance came from EM local currency debt, with the VanEck J.P. Morgan EM Local Currency Bond ETF rising by 0.5% for the week, buoyed by currency gains across Asian markets. China continues to present challenges for the broader EM space. The iShares USD Asia High Yield Bond ETF dropped by 1% over the week, pressured by ongoing weakness in the Chinese real estate sector. S&P recently downgraded Chinese developer Vanke’s long-term credit rating from BB+ to BB-, further weighing on market sentiment. Inflation data out of China provided little relief, with consumer prices rising by just 0.1% in August, leading to a year-on-year CPI increase of 0.6%. On the industrial side, PPI inflation slipped to -1.8% year-on-year, underscoring persistent deflationary pressures. Looking ahead, falling oil prices could add further strain to EM credits, particularly for commodity-reliant economies. With oil dipping below $70 per barrel, we may see continued pressure on EM spreads, as commodity exports are crucial to many emerging markets. Nonetheless, the broader EM debt market remains relatively resilient, with sovereign and local currency bonds providing a stable backdrop amid global uncertainties.
