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What happened last week?
Last week, the Federal Reserve made its first rate cut since March 2020, lowering interest rates by 50 basis points. This aggressive move underscores the Fed’s focus on shoring up the labor market, reflecting a shift in priorities away from curbing inflation. By initiating the monetary easing cycle, the Fed acknowledged that the current economic landscape calls for recalibration. The updated dot plot suggests a gradual path of rate cuts: two more in 2024, four in 2025, and two more in 2026, targeting a terminal rate of 2.875%. This projection is closely aligned with market expectations, though the market remains slightly more aggressive, pricing in three rate cuts for 2024 and between four to five in 2025, with a terminal rate of around 2.85%. Across the pond, the Bank of England (BoE) decided to hold interest rates steady at 5%. Governor Andrew Bailey stated that inflationary pressures, particularly in services, are persistent, but the overall economy is evolving as expected. While one member of the Monetary Policy Committee (MPC) favored a 25 bps cut, the majority voted for no change. If economic data continues along its current trajectory, the BoE is likely to implement a 25 bps rate cut at its next meeting on November 7. MPC member Catherine Mann argued for a more cautious approach, advocating higher rates to reduce inflation risks, with concerns that premature U.S. easing could spill over into the UK. Currently, the market is pricing in an 86% chance of a rate cut at the November BoE meeting. In Japan, the Bank of Japan (BoJ) kept its key rate unchanged at 0.25%, with the decision supported unanimously by the board. Governor Ueda noted that the upside risks to inflation have eased, pushing back the timeline for the next rate hike, which the market now expects in January 2026. Meanwhile, Norway’s central bank also held rates steady, indicating no plans to cut before 2025. Looking ahead, both the Reserve Bank of Australia (RBA) and the Swiss National Bank (SNB) are set to announce their rate decisions this week.
The credit market saw significant tightening last week, with U.S. investment-grade spreads tightening by 5 bps to reach 91 bps, their lowest level since July. This tightening offset the impact of rising interest rates, leading to a flat performance for the Vanguard USD Corporate Bond ETF over the week. Meanwhile, U.S. high-yield bonds performed well, posting a gain of +0.75% as spreads tightened by 25 bps to 300 bps. In the riskier segment of the market, CCC-rated high-yield bonds soared, benefiting from the Fed's jumbo rate cut, with spreads tightening by over 50 bps to their lowest level in more than two years. This marks a significant outperformance in the junkiest part of the market, although some caution is warranted as the gap between CCC and B spreads is at its tightest in years, potentially indicating underpriced risk. In corporate news, VF Corp, owner of brands like Vans, The North Face, and Timberland, was downgraded by Moody’s from investment grade (Baa3) to junk (Ba1), citing long-term challenges in turning around its financial performance. While the company has implemented cost reductions and realigned inventory strategies, Moody’s remains cautious about the company’s exposure to a challenging consumer spending environment. The company remains rated BBB- by S&P but with a negative outlook. In Europe, credit markets followed a similar trend, with the iShares Core Euro IG Corporate Bond ETF remaining flat, supported by a 6 bps tightening in investment-grade spreads. The European high-yield market also performed positively, with the iShares Euro HY Corporate Bond ETF gaining +0.4%. The AT1 market was the standout performer in Europe, delivering an impressive +1.4% weekly gain, bringing its year-to-date performance to +9%, rivaling the Eurostoxx index for total returns this year.
Following last week’s highly anticipated Federal Reserve rate cut, U.S. Treasury markets experienced a "sell the news" reaction, with treasuries losing 0.4% over the week. The yield curve steepened in a bearish fashion, as yields in the middle (belly) and long-term (back-end) sections of the curve rose about 10 basis points. The 10-year U.S. Treasury yield closed the week at 3.75%, up from 3.65%, which places it almost exactly at its historical average since 1995. Meanwhile, the 2s10s yield curve—a critical market barometer—steepened to 15 basis points, its highest level since June 2022. Historically, sharp reversals from inversion often signal upcoming recessions, so the recent move has caught the market’s attention. Another key development was the drop in the percentage of inverted U.S. yield curves, from 92% to 67%, the sharpest drop since 2020. In the past, such declines have frequently preceded economic downturns. Treasury Inflation-Protected Securities (TIPS) were the only segment of U.S. Treasuries to record gains, rising 0.1% last week. As rate volatility has receded, with the MOVE index falling below 100 to its lowest level since July, investors are taking advantage of falling yields by extending bond durations to lock in longer-term rates. This shift was evident as money market funds saw outflows of $20 billion—the largest weekly outflow since June. China’s holdings of U.S. Treasuries continued to shrink, hitting a 15-year low of around $780 billion, down 30% over the past three years. Foreign ownership of U.S. debt as a percentage of total debt has dropped from 35% to 24% over the past decade. In Europe, the bond market mirrored the U.S. sell-off, with the iShares Core EUR Govt Bond ETF falling 0.5%, driven by rising core yields, while peripheral bonds outperformed with some spread tightening. In the U.K., the iShares Core UK Gilts ETF fell 1.2%, following the Bank of England's rate decision. As markets digest the Fed’s recent move, attention will now shift toward U.S. elections and further economic data, particularly PCE inflation, which could add volatility to the bond market moving forward. For now, investors are taking advantage of lower rates by locking in yields, as the rate-cutting cycle begins to unfold.
Emerging market
Emerging markets (EM) saw solid performance last week, led by EM sovereign bonds. The iShares Emerging Market Sovereign Bonds ETF rose by +0.6%, driven by a 16 bps tightening in spreads to 300 bps—the first time spreads have tightened to this level since 2021. EM local currency bonds resumed their positive trend, gaining 1.1% over the week, while EM corporate bonds posted a more modest gain of 0.3%, accompanied by a 12 bps spread tightening. EM high yield bonds also performed well, with a +1% rise, primarily due to strong gains in Asian high yield bonds. In China, the People’s Bank of China (PBOC) cut its 14-day reverse-repo rate by 10 basis points to 1.85%, aligning with a similar reduction to the seven-day reverse repo rate earlier this year. This move hints at the potential for further stimulus efforts, as the PBOC may cut rates further to support China’s slowing economy, particularly following the Federal Reserve’s rate cuts. Meanwhile, China is also considering easing some of the most significant restrictions on home purchases to revitalize its housing market, which has seen a series of previous measures fail to stimulate demand. Additionally, officials are looking at measures to support the stock market as part of broader efforts to stabilize the economy. The Fed’s decision to cut rates by 50 bps was mirrored by central banks across the Gulf Cooperation Council (GCC), with Saudi Arabia, the UAE, Oman, and Bahrain all matching the Fed's move. Qatar went further, reducing rates by 0.55 percentage points, while Kuwait opted for a more modest 0.25 percentage point cut. Elsewhere, Turkey held its weekly repo rate at 50%, as expected. In Brazil, the BCB raised its key interest rate by 25 bps to 10.75%, marking the first increase since August 2022, as inflationary pressures remain skewed to the upside. In the corporate world, Teva Pharmaceuticals saw its long-term issuer default rating upgraded by Fitch to BB from BB-, while Costa Rica's long-term foreign debt rating was raised by Moody’s to Ba3 from B1, signaling a more positive outlook for both issuers.
