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What happened last week?
Uncertainty continues to dominate the outlook for U.S. monetary policy as the Federal Reserve weighs robust economic activity against mounting inflationary pressures. November’s “core” PCE deflator—a key gauge for the Fed—rose by +0.3%, pushing the annual growth rate to 2.8%, moving further from the Fed’s 2% target. Last week’s FOMC Minutes reinforced the Fed’s cautious tone. While additional rate cuts remain on the table, the central bank is opting for a gradual approach, emphasizing data-dependency. This means rate cuts may not occur at every meeting. A 25bp cut in December remains the most likely scenario, with a 65% probability priced in by the market, but the final decision hinges on upcoming employment and inflation data. With a 35% chance of no cut, the Fed appears focused on maintaining flexibility, avoiding premature moves that could derail its inflation-fighting progress. Across the Atlantic, the European Central Bank (ECB) faces a different reality. Weakening economic activity, political instability in France, and softer-than-expected inflation data in Germany and France are amplifying calls for significant monetary easing. While a 25bp rate cut at the ECB’s December meeting is almost a foregone conclusion, the possibility of a more aggressive 50bp cut has risen slightly to 17%. Most ECB officials are treading carefully, likely awaiting updated growth and inflation projections before committing to a larger move. However, a notable hawkish counterpoint came from Isabel Schnabel, who cautioned against moving too far into accommodative territory and advocated for a gradual return to neutral. In Switzerland, Swiss National Bank (SNB) President Martin Schlegel expressed concern over the strength of the Swiss franc, which continues to weigh on the economy. Schlegel hinted that a return to negative rates could not be ruled out if further CHF appreciation and inflation slowdown occur, underscoring the SNB’s readiness to act decisively if conditions warrant. As central banks navigate divergent economic challenges, their next moves will shape the trajectory of global monetary policy heading into 2025.
The U.S. bond market delivered solid gains last week, buoyed by a notable 20 basis point decline in yields across all maturities. This move was evenly split between a reversal in inflation expectations and a drop in real rates. The 10-year inflation breakeven rate fell by 10 basis points to its lowest level since early October, signaling reduced market concern over inflationary pressures. Declining real rates further bolstered bond prices, creating a favorable environment for fixed-income investors. Treasuries across the curve posted positive returns, with longer-term bonds leading the rally thanks to their higher sensitivity to interest rate movements. The iShares 10-20 Year Treasury Bond ETF soared +2.8%, while the iShares 3-7 Year Treasury Bond ETF and iShares 1-3 Year Treasury Bond ETF gained +0.9% and +0.3%, respectively. Inflation-protected securities also advanced, with the iShares TIPS Bond ETF up +0.7%, though it was partially restrained by the decline in inflation expectations. In Europe, a combination of disappointing economic data and softer-than-expected inflation reports drove yields lower across the board. German 10-year yields fell to their lowest levels in two months, reflecting the region's weak growth prospects. However, French government bonds underperformed amid escalating political gridlock and the rising likelihood of a government dismissal, which heightened domestic uncertainty. Conversely, peripheral sovereign bonds, such as Italy’s, capitalized on the declining rate environment. The Italian 10-year yield dropped to its lowest level in over two years, underscoring growing investor confidence in the region’s high-yielding debt. European government bonds delivered robust returns, with the iShares EUR Government Bond 10-15 Years ETF up +1.7%, outpacing the iShares EUR Government Bond 3-7 Years ETF, which gained +0.6% due to its lower duration sensitivity. Inflation-linked securities mirrored this strength, with the iShares EUR Inflation-Linked Government Bond ETF rising +0.8% during the week. The week’s rally highlights the ongoing sensitivity of global bond markets to inflation trends, economic data, and political developments, setting the stage for a closely watched year-end in fixed income.
Emerging market
Emerging market (EM) debt delivered a strong performance last week, buoyed by the decline in U.S. interest rates. The Bloomberg Emerging Markets Hard Currency Aggregate Index rose +0.9% for the week, closing November with a solid +1.1% gain. Corporate bonds tracked the positive momentum, with the iShares Emerging Market Corporate Bonds ETF up +0.7% both for the week and the month. Local currency debt also saw a strong rally last week, with the VanEck J.P. Morgan EM Local Currency Bond ETF climbing +1%. However, November performance for local currency bonds ended slightly negative at -0.4%, highlighting the challenges posed by EM currency volatility. Market sentiment toward EM bonds has been dampened by President Trump’s renewed rhetoric on tariffs, including a vow to impose a 25% tariff on Mexico and Canada. While Canada opted for diplomacy, Mexico’s newly elected President Claudia Sheinbaum adopted a firmer stance, warning Trump of retaliatory measures. Fund flows reflect this sentiment shift, with modest inflows from early October reversing into outflows in recent weeks. Amid these challenges, S&P provided a note of reassurance by maintaining Mexico’s mid-BBB rating with a stable outlook. S&P emphasized that the country’s investment-grade status remains secure, even if downgraded to the low BBB range. The agency highlighted pragmatism in U.S.-Mexico relations as critical, asserting that Trump’s eventual policies will carry more weight than his rhetoric. Elsewhere, Adani bonds partially recovered after Adani Green Energy clarified that its leadership, including Gautam Adani, faces securities fraud charges rather than bribery allegations under the U.S. Foreign Corrupt Practices Act. While the case presents ongoing risks, securities fraud charges are generally less severe than bribery allegations, offering some relief to investors. The next focal point will be the Trump administration’s approach to handling this high-profile legal case. A notable bright spot came from Saudi Arabia, where Moody’s upgraded the country’s rating by one notch to Aa3, citing robust non-hydrocarbon private sector growth, among the strongest in the Gulf Cooperation Council region. The agency also upgraded eleven Saudi banks, reflecting improved operating conditions and the government’s strengthened ability to support the financial sector. While EM bonds showed resilience last week, ongoing trade tensions, geopolitical risks, and idiosyncratic challenges highlight the importance of vigilance and selective positioning in this complex market environment.
