.png)
What happened last week?
Last week’s headline move came from the Bank of Canada, which reduced its key interest rate by 50 basis points to 3.75%, marking its first cut of this magnitude since the pandemic. This shift indicates a pivot from stringent inflation control towards bolstering economic growth, with inflation now within the central bank’s target range. Governor Tiff Macklem stated that the cut is intended to enhance economic resilience as signs of slowing momentum emerge. Looking ahead, economists anticipate a potential rate cut in December, though some suggest it may be a more measured adjustment to align with U.S. rates. In the U.S., Federal Reserve officials offered varied perspectives. Cleveland Fed President Beth Hammack highlighted that while inflation control is progressing, risks from geopolitical tensions and housing inflation remain. San Francisco Fed President Mary Daly supported further rate cuts to sustain a stable labor market amid easing inflation, while Kansas City Fed President Jeffrey Schmid advocated a slower approach to prevent market volatility. Schmid pointed to factors like a larger Fed balance sheet that could mean a “neutral” rate remains above pre-pandemic levels. Market expectations remain steady, with a rate cut anticipated at the upcoming November FOMC meeting and a 70% probability of another cut in December. In Europe, European Central Bank President Christine Lagarde confirmed that rate cuts are expected but emphasized a data-driven approach. She cited moderating inflation as promising, though high service costs and wage growth remain areas to monitor. Chief Economist Philip Lane echoed these sentiments, noting solid progress in disinflation alongside resilient consumer spending and investment. François Villeroy de Galhau from the ECB’s Governing Council called for timely policy adjustments to prevent unnecessary economic strain. The market currently anticipates a 25 bps rate cut in December, with a 40% likelihood of a larger 50 bps reduction. In the UK, Bank of England rate-setter Catherine Mann expressed concern that recent cuts might have been premature, given lingering service sector inflation. Her caution contrasts with Governor Andrew Bailey’s more upbeat view, citing a faster-than-anticipated inflation drop, which increases the probability of another cut in November and the potential for additional easing in December.
The credit market remains relatively stable, though it continues to be influenced by ongoing rate volatility. After reaching a low of 79 bps on October 17—its lowest since 2005—U.S. Investment Grade (IG) corporate spreads widened slightly, closing the week at 82 bps. Although the volatility of IG bonds remains contained, the VIXIG index ended the week at 31, above its 2024 average of 28, reflecting the indirect impact of rate volatility on corporate bonds. Consequently, the Vanguard USD Corporate Bond ETF declined by -0.9% for the week. In high yield (HY), U.S. spreads hit a three-year low of 283 bps before stabilizing at 285 bps. Despite relatively tight spreads, the iShares Broad USD High Yield Corporate Bond ETF lost -0.7% due to rising rates, leaving U.S. IG bonds up just +3.6% year-to-date, while HY maintains a solid performance of +7.6% YTD. In Europe, IG corporate spreads tightened further to 104 bps, reaching their lowest level since 2022. Although spreads remain well above pre-2008 levels, spreads across various ratings have compressed to their tightest since 2015, reflecting relative resilience in European credit. The iShares Core Euro IG Corporate Bond ETF was down only -0.2%, faring better than its U.S. counterparts. European high-yield spreads continued tightening to 343 bps, their lowest since June. Despite interest rate pressures, the iShares Euro HY Corporate Bond ETF remained flat over the week, with weakness in European CCC-rated bonds, which dropped -2.3%. In the subordinated debt market, performance diverged, with financial AT1s underperforming as the WisdomTree AT1 CoCo Bond ETF fell -0.7%. Corporate hybrids showed relative strength, with the Invesco Euro Corporate Hybrid ETF remaining flat. Meanwhile, in the U.K., Gilt yields have underperformed, especially at the long end, amid concerns over potential fiscal policy shifts under Labour, raising expectations of increased government borrowing. Despite this, JPMorgan suggests the recent yield gap between GBP and EUR bonds may be overdone, as Labour is expected to adopt a cautious fiscal approach. This setup could spur a rally in 10-year Gilts by year-end, with GBP long-term bonds maintaining a yield premium (~25bps) over EUR bonds, particularly after currency adjustments. The iShares Core £ Corp Bond UCITS ETF slipped -0.8% for the week, yet it remains up +1.6% YTD, compared to +3.7% for the iShares Core Euro IG Corporate Bond ETF.
U.S. bond market volatility persisted last week, with the 10-year Treasury yield climbing 15 basis points to 4.23%, driven by an increase in real rates. The 10-year real yield saw a notable rise of 16 basis points, reaching 1.94%. While long-term breakevens held steady, the Bloomberg Commodity Index rose by 2%, pressuring short- and medium-term breakevens, which spiked by 6 basis points. Robust U.S. economic data is also a factor, with the Citi U.S. Economic Surprise Index hitting 23—its highest since April—indicating that economic resilience continues to exceed market expectations. As a result, the term premium turned positive at 0.23, a 2024 peak, reflecting investors' demand for greater compensation on long-term risk. The MOVE index, a key gauge of bond market volatility, surged to a year-to-date high of 128, signaling heightened market anxiety amid these developments. Additionally, a recent rise in polling for Donald Trump has fueled concerns around potential fiscal expansion, adding further pressure on rates. In this context, the iShares USD Treasuries ETF fell by -0.8%, while the iShares USD TIPS ETF slipped -0.9%. Long-dated Treasuries faced sharper declines, with the iShares 20+ Year Treasury Bond ETF losing nearly 2% over the week, pushing it down 4% year-to-date, the lowest level since July. In Europe, while U.S. rates have surged since mid-September, the Eurozone has experienced a more subdued reaction, partially due to a meaningful progress in inflation reduction while the Citi Eurozone Economic Surprise Index is still negative. The ECB remains on track with its rate-cutting agenda, as several ECB members reiterated that additional rate cuts are expected in December, with potential for a 50 basis-point reduction (low probability). As a result, the yield gap between U.S. and German 10-year bonds has widened to nearly 2%, a level last seen in May 2024. Eurozone yields rose modestly last week, with the 10-year German yield up 10 basis points to 2.30%. The German yield curve has also steepened, with the 2-10 year spread increasing by 10 basis points to 20 basis points, marking the steepest level since October 2022. Italian spreads, after reaching their lowest level since 2021, widened by 5 basis points to 121 bps, while French spreads remained stable below 80 bps, despite Moody’s Friday revision of France’s credit outlook to “negative” from “stable.” In this context, the iShares Core EUR Govt Bond ETF lost 0.8%. In the UK, bond yields rose in alignment with global markets and driven by UK budget fears (next week), despite slightly weaker-than-expected PMIs (though still in expansion territory). The iShares Core UK Gilts ETF declined by -1% for the week.
Emerging market
Emerging market (EM) bonds were under pressure last week, impacted by rising U.S. interest rates and a stronger dollar. While EM spreads held steady, returns were broadly negative, with the iShares Emerging Market Sovereign Bonds ETF and the iShares Emerging Market Corporate Bonds ETF down by -1.2% and -0.7%, respectively. Local currency bonds faced additional headwinds as emerging market currencies saw their fourth consecutive week of declines, the longest depreciation streak since 2022. This currency weakness contributed to a -1% drop in the VanEck J.P. Morgan EM Local Currency Bond ETF. Investor caution towards EM assets has been amplified by geopolitical uncertainty around the upcoming U.S. elections and concerns over potential tariffs on EM imports if Donald Trump returns to office. The MSCI EMFX index reflected this sentiment with a 0.1% decline on Friday, particularly affecting currencies from countries like Mexico, Brazil, the Philippines, and South Korea. The Mexican peso, for instance, is nearing the critical 20/USD threshold and remains vulnerable to trade policy shifts. Similarly, the Colombian peso is under strain amid budgetary concerns, while Brazil’s real has faced pressure from anticipated public spending increases. In country-specific moves, Argentina’s dollar-denominated bonds rallied on optimism surrounding candidate Javier Milei’s proposed fiscal reforms. Meanwhile, Turkish officials are reportedly considering easing short-selling restrictions to attract foreign investment, and Ecuador’s bonds weakened due to ongoing power outages. The IMF’s World Economic Outlook maintains a steady growth forecast for emerging markets at 4.2% for 2024 and 2025. China’s growth is projected to moderate, while India, Indonesia, and the Philippines are expected to lead EM expansion in Southeast Asia. Public deficits in key economies, including China, India, and Brazil, remain elevated but manageable, with global risks from rising protectionism and geopolitical conflicts posing significant challenges. Morocco, for instance, plans to ease its currency peg to the euro and dollar by 2026, a step towards a free-floating dirham, and intends to issue $1 billion in eurobonds by early 2025, likely waiting until after the U.S. election to mitigate geopolitical risk.
