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What happened last week?
Last week, the U.S. Federal Reserve left its policy rate unchanged at 4.25–4.5%, as expected. Chair Powell reaffirmed the Fed’s “data dependency” while noting economic resilience: labor markets remain firm, consumption is solid, and inflationary pressures — though easing — persist. The Summary of Economic Projections leaned hawkish, with more FOMC members now expecting no rate cuts in 2024 and fewer cuts in 2025–2026. Markets interpreted this as a sign that rate cuts will be gradual, with just 45–50 bps priced by year-end. Yet, Governor Waller tempered the tone Friday, suggesting a cut could come as soon as July if inflation trends lower. Elsewhere, Switzerland’s SNB delivered its second 25 bp rate cut this year, bringing rates to 0%. While inflation remains well-contained, SNB Chair Schlegel emphasized the risk of deflation if the franc strengthens excessively. Markets sharply reduced expectations for negative rates, pricing in just a 50% chance of another cut in H2. In contrast, the BoE stood pat with a 6–3 vote, though the dovish tilt grew: three members favored an immediate cut, and Governor Bailey hinted at easing “over the summer.” The Riksbank and Norges Bank surprised by cutting rates as well, citing easing inflation and weaker growth outlooks. For now, the theme is clear: the Fed and BoE favor caution, while smaller central banks are seizing the chance to ease. Diverging policies set the stage for relative value plays in global rates and FX. The question is how long this split can persist without triggering cross-market volatility.
Credit markets once again defied gravity, grinding tighter despite macro noise. U.S. investment-grade spreads narrowed by around 3–5 bps, reaching multi-year lows near 110 bps. High yield followed, with spreads compressing 10–15 bps to about 350 bps, approaching post-COVID tights. Total returns were solid: U.S. IG ETFs gained +0.3%, HY added +0.5%, and Euro IG rose +0.2%. Only Euro HY lagged slightly, down 0.1%, reflecting heavier primary market issuance. Investor appetite remains robust, driven by carry and low default expectations. Default rates in U.S. HY remain under 2%, and dispersion remains contained. The recent downgrade of Warner Bros. Discovery to junk status barely ruffled the market. Spreads widened modestly but found buyers quickly — highlighting deep liquidity and preparedness in both IG and HY funds. In Europe, “reverse Yankee” issuance hit a YTD record of EUR 77bn, as U.S. firms continue to take advantage of lower European yields and high investor demand. On the lower-quality side, CCCs still trade with a premium, suggesting room for selective tightening if defaults stay low. Yet the mood isn’t without caution. Ultra-tight spreads offer little protection if growth deteriorates or rates rebound. Also, increased leverage via buybacks or M&A could sow future risk. Sector-wise, telecoms and CRE remain under scrutiny. For now, though, the Goldilocks environment — decent fundamentals, high carry, supportive technicals — is holding. Investors are staying “up in quality,” favoring single A over BBB and BB over B in HY.
Despite an eventful macro week, U.S. and European rates were surprisingly stable. The U.S. 10Y Treasury yield ended the week near 4.33%, with the curve still inverted as the 2Y settled around 3.90%. The inversion narrowed slightly, reflecting expectations of eventual Fed cuts — but the move wasn’t dramatic, suggesting markets anticipate a soft landing rather than aggressive easing. German 10Y yields followed a similar path, drifting slightly lower to 2.48%, while U.K. 10Y gilts stayed elevated at 4.50% after the BoE’s hold. Beneath the surface, inflation breakevens told a different story. The U.S. 10Y breakeven rose to 2.34%, its highest since early June, tracking the rise in crude oil. Yet real yields fell, pointing to investor concerns over growth rather than inflation acceleration. The MOVE index — a gauge of rate volatility — declined to the low 90s, indicating markets have growing confidence in the central bank roadmap, despite geopolitical noise. In terms of ETF performance, intermediate and long-end U.S. Treasury funds gained +0.3% to +0.5%, while TIPS rose +0.6% thanks to the drop in real rates. European sovereign bond ETFs also posted mild gains of +0.1% to +0.2%, although Swiss bond ETFs declined sharply due to rising CHF yields (+11 bp on the 10Y), as rate cut expectations were dialed back. Looking ahead, divergence in global monetary policy is setting the stage for tactical duration positioning. With U.S. yields still elevated compared to peers — even exceeding Italian BTPs — relative value in core vs. semi-core bonds is becoming more compelling. Meanwhile, breakevens are showing oil inflation hasn’t fully faded. Chart of the Week: U.S. 10Y breakeven vs. Brent oil – diverging paths, converging questions. While oil surged 10% this month, inflation expectations remain well anchored — for now
Emerging market
Emerging markets delivered another week of steady gains, buoyed by supportive U.S. rates and resilient EMFX. The JPM EMBI Global rose +0.5%, while EM corporate bonds edged up +0.2%. Local-currency bonds remained in demand, with the EMLC ETF gaining +0.7%, driven by currency strength in Brazil and South Africa. Geopolitical risks in the Middle East — notably shipping disruptions near the Strait of Hormuz — had only a muted impact, despite oil’s rally. Investors seem focused on the broader narrative: a soft USD, peaking global rates, and improved EM fundamentals. Still, should energy markets flare up again, that calm could be tested — especially for oil-importers or external borrowers. On the issuance front, Hungary raised $4bn across three tranches, finding strong demand despite EU frictions. Meanwhile, India’s Adani Ports returned to markets with a successful ₹50bn local bond, signaling renewed confidence after last year’s turbulence. More EM corporates are favoring local issuance to reduce dollar risk — a trend likely to continue as FX volatility subsides. Flows into EM bond funds accelerated again last week, adding to the $3.8bn inflow streak that began in early June. Even Asia high-yield, despite continued weakness in Chinese real estate, saw stabilizing performance (–0.3%), as policymakers hint at further stimulus. The search for yield is back — but investors remain selective. Local bonds in Brazil, Mexico, and India are favored for their positive real rates, while caution prevails in frontier markets and China-linked credit. As global rates peak, EM offers rare convexity. The key? Stay diversified and nimble. If the Fed surprises, the rally could reverse — but for now, EM debt enjoys the tailwind of a macro regime shift.
