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What happened last week?
Credit
As credit spreads have narrowed significantly in recent months, the credit market remains largely driven by changes in interest rates, pending a significant credit market event. The slight premium on investment-grade corporate bonds, less than 1%, continues to attract investors. Bank of America reports that investment-grade bonds have seen their 28th consecutive week of inflows, setting a course for record inflows in 2024. This trend is supported by a positive outlook on the U.S. economy and corporate health, alongside a diversification drive away from U.S. Treasuries, which are currently challenged by increased supply, waning foreign demand, and the backdrop of a high U.S. fiscal deficit. Despite these factors, U.S. IG credit spreads remained stable at 87 bps this past week, leading the Vanguard USD Corporate Bond ETF to a modest weekly gain of nearly +0.2%. In the U.S. high-yield sector, the market softened slightly with credit spreads widening. The Bloomberg U.S. High Yield Index saw its spreads increase by 5 bps to 298 bps. Consequently, the iShares USD High Yield Corporate Bond ETF declined by 0.2% over the week. In Europe, the lower activity in the primary market combined with the ongoing economic recovery provided technical support to the credit market. European IG credit spreads tightened by 2 bps to 110 bps, while European high-yield credit spreads narrowed by almost 10 bps to 348 bps. The higher yield premium compared to the U.S. could benefit the European credit market going forward, especially if European economies continue their recovery trajectory. The iShares EUR High Yield Corp Bond ETF ended the week flat, while the iShares Core EUR Corp Bond ETF saw a slight decrease of -0.1%, impacted by rising European interest rates. Interestingly, last week marked a rebound in European contingent convertible (CoCo) bonds, driven by fresh market activity including a EUR 1.5 billion AT1 issuance from Banco Santander and a £1.25 billion AT1 issuance from Barclays. This revitalized interest provided a positive boost to the asset class, with the WisdomTree AT1 CoCo Bond ETF posting a gain of +0.8% over the week.
Rates
In the U.S., the Treasury market has adjusted to a reduced likelihood of interest rate cuts in 2024, following a series of Federal Reserve remarks hinting at a sustained cautious approach and signs of slowing economic momentum. The U.S. Economic Surprise Index has turned negative for the first time in a year, indicating a tapering of economic activity. This sentiment led to an increase in shorter-term yields, with the 2-year Treasury yield rising 6 basis points to end the week at 4.87%. Conversely, longer maturities saw modest gains; the 10-year yield remained nearly unchanged, just below 4.5%, while the 30-year yield decreased by 3 basis points to 4.63%. The Treasury market faced a significant influx of supply, with $125 billion in T-Notes issued this week. Notably, the 10-year auction saw lackluster demand, sparking a brief sell-off in rates. However, rates partially recovered following a weaker-than-expected U.S. initial jobless claims report. Both the 3-year and 30-year auctions attracted more favorable receptions. Despite these fluctuations, the iShares U.S. Treasury ETF closed the week nearly flat (+0.04%) and is up 1.1% month-to-date. In Europe, trading was subdued due to a shorter week and reduced liquidity. The iShares Core EUR Government Bond ETF ended the week down by 0.2%, influenced by a bear flattening where short-term yields rose by 5 basis points and long-term yields by only 2 basis points. The 10-year German yield continues to hover around 2.5%. The UK bond market experienced a positive week, bolstered by the Bank of England's dovish tone despite robust GDP figures. For the first time in three years, UK economic growth outpaced that of the U.S. and the eurozone, registering a 0.6% expansion in Q1. This growth spurred investor confidence, contributing to a 0.7% weekly gain for the iShares Core UK Gilts ETF.
Emerging market
In the realm of emerging markets, Latin American giants Brazil and Mexico are taking a more conservative approach to monetary policy due to internal economic pressures. Brazil's central bank made a cautious rate cut of 25 basis points, reducing the Selic rate to 10.50%. This smaller-than-expected adjustment was influenced by worries about unanchored inflation expectations and the credibility of fiscal policies, signaling that future easing may be limited. Similarly, Mexico’s central bank (Banxico) held interest rates steady at 11%, with a unanimous vote reflecting updated inflation forecasts that suggest a slower reduction in inflation than previously expected. Both central banks are navigating the dual challenges of persistent inflation and economic growth concerns, which has led them to adopt monetary policies that closely align with global trends, including the Federal Reserve's current approach. Despite their cautious stance, emerging market fixed income showed signs of improvement last week, with all major indices registering gains. Sovereign bonds in emerging markets rose by 0.5%, corporate bonds by 0.3%, and local currency bonds also increased by 0.3%. In Brazil, bonds from Braskem, the petrochemical giant, experienced a significant drop early in the week—nearly 5 points—after the Abu Dhabi National Oil Company (Adnoc) halted its negotiation process for acquiring a substantial stake in the company. However, these bonds managed to recover their losses throughout the week. The situation in China also reflects a cautiously optimistic outlook, particularly in the junk bond market, which saw gains of 0.6% over the week and an impressive 9% increase year-to-date. A recent meeting of China's Politburo indicated that President Xi Jinping is preparing to intervene significantly in the real estate sector to counteract a severe housing slump now affecting state-owned enterprises (SOEs). With property sales declining among SOEs, similar to earlier trends seen among private developers, Beijing plans coordinated actions to address the surplus housing inventory, with state-backed enterprises likely to benefit the most from these measures. Lastly, Turkey received a positive nod from S&P, which upgraded its long-term foreign currency debt rating to B+ with a positive outlook. The country's credit default swap (CDS) rates are well entrenched below 300 bps, currently standing at 283 bps, indicating a stabilizing economic perception among investors.
