What happened last week?
In the U.S., Fed Chair Jerome Powell cautioned against premature expectations of rate cuts, emphasizing a cautious stance and the potential for further policy tightening if necessary. Despite market speculation favoring rate cuts in early 2024 (March rate cut odds hit 70%), Powell reaffirmed the Fed's dedication to maintaining a restrictive policy until confident in achieving the 2% inflation target. Some officials, like Governor Christopher Waller, suggested the possibility of rate cuts if inflation declines, citing guidelines such as the Taylor Rule. Powell, however, expressed reluctance to speculate on policy easing, emphasizing a careful approach due to the risks of both under- and over-tightening. The Fed's monetary policy now appears to be more balanced between an extended pause and a rate cut than another round of tightening. In Europe, there is growing confidence in the market that the ECB will implement rate cuts in the early months of 2024, with over a 60% probability of a rate cut by March and a 100% chance of multiple rate cuts by April. The unexpected acceleration in the decline of inflation is likely to generate differing opinions among ECB members. On the dovish side, peripheral ECB members have expressed concerns. Italy's Governor, Fabio Panetta, emphasized the ongoing disinflation and the need to prevent unnecessary harm to economic activity and risks to financial stability, which could ultimately undermine price stability. On the contrary, core countries are cautious about celebrating low inflation. Bundesbank President Joachim Nagel mentioned on Thursday that inflation risks are tilted to the upside, and it is premature to consider a potential interest-rate cut. The upcoming ECB meeting in two weeks is anticipated to focus on the reduction of the Balance Sheet, specifically the end of PEPP reinvestments.
EM bonds reaped the rewards of the comprehensive market rally across both fixed income and equity markets, with a particular highlight on EM Sovereign bonds capitalizing on their extended duration. The Bloomberg EM Sovereign bonds index gained +6.7%, while the Bloomberg EM corporate bonds index rose +4.3%, and the Bloomberg EM Local currency bonds index increased by +4.8%. Year to date, EM sovereign bonds led with a +5.7% gain, EM local CCY bonds rose +4.0%, and EM corporate bonds +3.4%. The credit spread of EM corporate bonds reached 290 bps, its tightest level since May 2021. However, it's important to note that 2023 witnessed a high level of default rates in EM High Yield, anticipated to end the year at 10%, a decline from the almost 15% default rate recorded in 2022. This was primarily driven by the Russia/Ukraine conflict and the China real estate market downturn. The China real estate market continues to face challenges; the sales of China's top 100 property developers fell 14.7% YoY, growing only 1.6% from January to October 2023. In November, the PBOC introduced additional easing measures for the real estate sector, stimulating China real estate bonds. The iBoxx USD China real estate bonds gained +12% in November but remain more than 50% lower year to date. The Asia and Latin America regions were the top performers in November within the Emerging Market fixed income universe. EM bonds flows remained negative year to date at -$30 billion.