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What happened last week?
Fed and ECB Deliver as Expected, While Rate Cut Bets Intensify!
Last week, the world’s two most influential central banks— the Federal Reserve and the European Central Bank—held their first monetary policy meetings of 2025, both delivering decisions that aligned precisely with market expectations. The Fed opted to keep its benchmark rate unchanged in the 4.25%-4.50% range, following three consecutive cuts at the end of 2024. The official statement reflected confidence in the resilience of the U.S. economy, noting solid growth and a labor market that remains tight, with unemployment stabilizing at low levels. However, inflation remains “somewhat elevated,” and policymakers acknowledged that progress toward the 2% target had stalled, justifying the decision to hold rates steady. In his press conference, Fed Chair Jerome Powell reinforced this cautious stance, repeatedly stating that the Fed is in "no hurry" to adjust its policy stance further. He emphasized that rate cuts would only resume once there is clear evidence of a slowdown in inflation or a deterioration in employment conditions. While Powell hinted at the likelihood of further inflation moderation later this year—potentially warranting additional easing—he made it clear that the Fed is content with waiting for greater clarity before moving forward. This messaging reinforced market confidence in a prolonged pause, with futures markets maintaining their expectation of no rate cut at the March 19 meeting and marginally increasing their confidence in two 25bp cuts by year-end. As a result, expectations for 2025 rate cuts drifted slightly higher to 48bp (up from 42bp a week earlier). The ECB followed suit the next day, delivering its widely anticipated 25bp rate cut, marking the fifth reduction since the easing cycle began in June 2024. With the Deposit Rate now at 2.75%—its lowest level in nearly two years—the ECB sent a clear message that further easing remains on the table. President Christine Lagarde emphasized that the "disinflation process is well on track" and that policy remains "restrictive" in a Eurozone economy still facing headwinds. However, she refrained from providing a clear indication of how far rates could fall, stating that it would be "premature" to discuss the terminal point of the cycle. Markets took this as a sign that further easing is likely but not on autopilot. Following the meeting and the release of softer-than-expected inflation data from Germany and France, futures markets adjusted their expectations, pricing in an additional 85bp of cuts this year—up from 62bp the week before. The dovish shift extended to the UK, where expectations for Bank of England rate cuts also climbed. Markets are now fully pricing in a 25bp cut at this week’s meeting (February 6), with 76bp of total cuts expected by year-end (up from 68bp last week). Meanwhile, in Japan, the BoJ’s recent 25bp rate hike was followed by firmer-than-expected inflation data, prompting traders to raise their expectations for additional tightening. Futures markets now anticipate an additional 32bp of hikes by year-end.
Resilient Performance Despite Tariff Risks and Deepseek.
The announcement of Deepseek had a pronounced impact on equity markets but left credit markets largely unscathed, as U.S. Big Tech companies are not significant bond issuers. Despite the introduction of new U.S. tariffs on Canada, Mexico, and China, U.S. investment-grade (IG) credit widened only slightly, with spreads increasing by just 2bps to 82bps last week. However, IG spreads remained flat for January, highlighting the market’s resilience. The Vanguard USD Corporate Bond ETF gained +0.5% over the week (same ytd), building on its previous +0.3% gain, underscoring stable demand for high-quality corporate debt. The U.S. high-yield (HY) market saw a modest widening, with spreads moving 8bps higher to 268bps. Despite this, HY spreads remained 24bps tighter over the month, reflecting strong underlying technicals. Trump’s pro-deregulation stance and a manageable maturity wall have bolstered confidence in the HY market, attracting continued fund inflows. The iShares Broad USD High Yield Corporate Bond ETF held steady last week and remains up +1.2% year-to-date. The IG primary market in both the U.S. and Europe kicked off the year with strength, surpassing the five-year median issuance for January. In contrast, HY issuance has been sluggish in both regions, pushing year-to-date HY net issuance into negative territory. Combined with growing investor appetite for leveraged loans, this lack of new HY supply could serve as a technical tailwind for the secondary market in the coming months. European IG credit outperformed its U.S. counterpart, as uninterrupted fund inflows continued amid the ECB’s rate cut cycle. Euro IG spreads ended January at 90bps, tightening by 11bps over the month, while Euro HY spreads compressed by 9bps to 302bps. This tightening trend was reflected in ETF performance, with the iShares Core Euro IG Corporate Bond ETF climbing +1.0% last week, while the iShares Euro HY Corporate Bond ETF gained +0.5%, benefiting from the ECB’s latest rate cut. High-beta credit segments continued to deliver strong returns. The WisdomTree AT1 CoCo Bond ETF rose +0.4% last week and is up +1.2% year-to-date. European corporate hybrids also outperformed, surging +0.7% for the week and bringing their year-to-date return to +0.6%. Overall, credit markets remain well-supported by robust technicals, solid fund inflows, and healthy corporate fundamentals. However, lingering tariff risks could introduce volatility, particularly in sectors with high trade exposure. While the backdrop remains constructive for credit, investors should remain vigilant as global policy shifts continue to unfold.Bonds Rally into Month-End Despite Tariff Shock!
Global bond markets wrapped up January on a positive note, cementing a solid start to 2025 despite a turbulent backdrop. U.S. Treasury yields declined into month-end, with the 10-year yield closing at 4.53%, down 9bps over the week and marginally lower from its 4.57% starting point at the beginning of the year. The move was entirely driven by lower real yields, while inflation expectations surged, with 10-year breakevens rising by 10bps to 2.43%, fueled by growing concerns over trade tariffs and rising oil prices (+2% in January). Inflation-linked bonds emerged as the top performer, with the iShares USD TIPS ETF gaining over 1.0% in January, leading all major U.S. bond segments. The iShares USD Treasuries ETF also posted a respectable +0.5% monthly return. However, bond markets are now bracing for potential turbulence after Donald Trump announced over the weekend a sweeping 25% tariff on imports from Mexico and Canada, alongside a 10% duty on Chinese imports. Notably, Canada supplies 62% of U.S. crude imports, and a 10% tariff on oil from Canada—set to take effect on Tuesday—could drive diesel prices higher. With trucking being the backbone of the U.S. economy, these tariffs are expected to lift core PCE inflation by 0.7% and shave 0.4% off GDP growth. The U.S. yield curve steepened by 2bps to 34bps over January but could face flattening pressure if these tariffs persist, putting further upward pressure on breakevens. In response to the news, the 5-year U.S. breakeven rate jumped to 2.66%, its highest level since March 2023—potentially a red flag for the Federal Reserve, which has little tolerance for resurging inflation risks. In Europe, President Lagarde’s dovish ECB stance provided support to government bonds, allowing the market to close January on a stronger footing. The iShares Core EUR Govt Bond ETF gained +0.8% last week, but still ended the month slightly negative (-0.1%). However, European inflation expectations ticked higher, with German breakevens rising 12bps to 1.9% in January, reflecting lingering market concerns over the ECB’s ability to contain inflation. The 10-year German Bund yield climbed 10bps to 2.46%. Meanwhile, peripheral spreads tightened over the month, with Italian 10-year spreads narrowing by 6bps to 109bps, French spreads tightening by 8bps to 73bps, and Spanish spreads compressing by 9bps to 60bps—driven by Spain’s strong economic outperformance, with the country posting the fastest growth rate in the Eurozone. In the UK, gilts ended the month on a solid note despite heightened volatility. The 10-year Gilt yield edged down by 3bps to 4.53%, while the Vanguard U.K. Gilt UCITS ETF gained +0.5% in January. Japanese government bonds, however, stood out as the worst performer in global fixed income. The iShares Core JP Government Bond ETF declined -0.6%, weighed down by rising inflation expectations and the BoJ’s aggressive shift in monetary policy. The 25bp rate hike announced in January propelled the 10-year JGB yield to 1.26%, its highest level since 2008. This move underscores Japan’s ongoing transition toward policy normalization, a factor likely to drive continued volatility in the JGB market.
Emerging market
Strong Start to 2025, but Fiscal and Trade Risks Loom.
Emerging market (EM) bonds delivered a solid performance in January, supported by falling U.S. rates and a stable dollar. The iShares Emerging Market Sovereign Bonds ETF gained +1.7%, while the iShares Emerging Market Corporate Bonds ETF added +1.0%. Local currency bonds outperformed, with the VanEck J.P. Morgan EM Local Currency Bond ETF surging +2% as EM currencies strengthened. Sovereign spreads tightened by 20bps to 234bps, reflecting strong investor demand, while corporate spreads narrowed by 4bps to 209bps. In China, the property sector showed signs of stabilization, with S&P suggesting that surging secondary sales could drive recovery in late 2025. This optimism lifted the iBoxx USD Asia China Real Estate High Yield Bond Index by +2% in January. South America saw Ecuador emerge as a top performer. Ecuador’s sovereign bonds exited distress territory, with spreads over U.S. Treasuries falling below 1,000bps for the first time since 2022. The rally was fueled by President Daniel Noboa’s widening lead ahead of the February 9 elections and his market-friendly policies, including securing a $4 billion IMF deal and cutting subsidies. Colombia faced fresh challenges, with Barclays downgrading its sovereign bonds to underweight due to a worse-than-expected 2024 fiscal deficit (6.8% vs. 5.6% target). The risk of a credit rating downgrade looms, while the central bank is expected to cut rates by 25bps to 9.25%, though divisions persist on the pace of easing. A U.S.-Colombia trade spat over deportation policies nearly led to steep tariffs on Colombian exports, adding to uncertainties. Meanwhile, Mexico secured a temporary pause on planned U.S. tariffs by deploying 10,000 National Guard troops to tighten border security. In the Middle East, a ceasefire between Israel and Hamas boosted sentiment, with Lebanon’s sovereign bonds rallying +24% in January. Egypt also benefited as Houthi attacks on Red Sea shipping paused, easing disruptions that had cut Suez Canal revenues by 60%. While EM debt remains well-supported by strong technicals and easing global rates, fiscal and trade risks remain key factors to watch.
