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What happened last week?
In the U.S., robust economic growth and a resurgence in inflationary pressures are reshaping expectations for the Federal Reserve’s policy trajectory. With GDP on track for 2.5% growth in Q4, and the potential for inflationary fiscal policies and tariffs in 2025, downside risks to the economy appear limited. Federal Reserve officials have highlighted the need for caution. Michelle Bowman emphasized a careful approach to lowering rates, while Susan Collins acknowledged the necessity for some easing but stressed the importance of data-driven, measured adjustments. Reflecting this cautious stance, futures markets now assign just a 55% probability to a December rate cut and price in no more than two 25-basis-point cuts by mid-2025. The Fed’s deliberate pace underscores its focus on balancing strong growth with rising inflation expectations. Across the Atlantic, the ECB faces a starkly different reality. Weak economic data, including November’s flash PMI slipping to recessionary levels, paints a picture of stagnating growth. Meanwhile, inflationary pressures continue to ease, with ECB officials expressing optimism. François Villeroy de Galhau stated that “victory against inflation is in sight,” reinforcing expectations for continued monetary easing. Markets are increasingly pricing in a 50-basis-point rate cut at the December meeting, a shift from the previously anticipated 25-basis-point reduction. This reflects a growing urgency to support the Eurozone’s faltering economy as inflation risks recede. In the UK, a mixed picture is emerging. October’s inflation surprise initially dampened expectations for near-term rate cuts, but dismal November PMI data reignited concerns about stagflation. This uncertainty underscores the challenges faced by the Bank of England as it balances inflation management with the need to support weakening economic activity. As central banks on both sides of the Atlantic respond to diverging growth and inflation dynamics, the coming months will be critical in shaping the trajectory of global monetary policy. Investors are watching closely to decipher the implications for rates and broader market conditions.
The U.S. bond market navigated a week of mixed signals, resulting in modest positive performance. Expectations for fewer Federal Reserve rate cuts put upward pressure on short-term yields, with the 2-year Treasury yield climbing to 4.36%, its highest since July. However, long-term yields edged lower, driven by weaker economic data from Europe and escalating geopolitical tensions. The conflict between Russia and Ukraine intensified as U.S. and U.K. long-range missiles were reportedly used, prompting a flight to safety. This dynamic pushed real yields down while inflation expectations ticked slightly higher, keeping the 10-year breakeven rate stable around 2.35%, consistent since Donald Trump’s election. The interplay between short- and long-term rates created diverging performances across the Treasury curve. Long-term bonds were the standout, with the iShares 10-20 Year Treasury Bond ETF rising +0.4%, while the iShares 3-7 Year Treasury Bond ETF gained only +0.1%. Short-term bonds lagged, as the iShares 0-3 Year Treasury Bond ETF ended the week flat. Treasury Inflation-Protected Securities (TIPS) benefited from the combination of declining medium-to-long-term rates and rising inflation expectations, lifting the iShares TIPS Bond ETF by +0.4%. In Europe, a weaker economic outlook and heightened geopolitical concerns weighed on EUR rates, driving yields lower across the curve. Germany led this safe-haven rally, with its bond yields falling the most, while France, Italy, and Spain also saw declines, though less pronounced. These movements supported solid performance in European government bonds, with the iShares EUR Government Bond 10-15 Years ETF gaining +0.6% and the iShares EUR Government Bond 3-7 Years ETF rising +0.4%. However, declining inflation expectations in the Eurozone muted gains for inflation-linked securities. The iShares EUR Inflation-Linked Government Bond ETF underperformed but still managed a slight +0.1% gain. As divergent economic conditions and geopolitical risks persist, the rate market's tug-of-war continues, highlighting the sensitivity of bond performance to shifts in both monetary policy expectations and broader global developments.
Emerging market
Emerging market (EM) bonds began to stabilize last week, recovering from initial volatility triggered by Trump’s victory. However, the prospect of trade tariffs continues to cast a shadow over many EM economies, with potential implications for global trade and economic growth. Performance across EM debt was mixed. The iShares Emerging Market Sovereign Bonds ETF gained +0.42%, supported by investor demand for sovereign debt, while the iShares Emerging Market Corporate Bonds ETF saw a marginal decline of -0.04%. Local factors and geopolitical risks drove nuanced market reactions. In Mexico, Moody’s placed the country’s Baa2 rating on negative outlook following the announcement of the 2025 budget by the Sheinbaum government. The budget allocates $6 billion to PEMEX, addressing its dollar and euro bond maturities in 2025, while bank loans are expected to be rolled over. PEMEX’s new CEO, Victor Rodriguez, affirmed that the company does not plan to tap bond markets this year. Even in the event of a downgrade, analysts anticipate it would be limited to one notch, keeping Mexico within investment-grade territory. India faced turbulence as the Adani Group came under scrutiny from the U.S. Securities and Exchange Commission (SEC) and Department of Justice (DOJ). Three Adani entities have been accused of paying $250 million in bribes to Indian officials tied to solar contracts. S&P revised Adani Ports and Special Economic Zone’s BBB- rating to a negative outlook, citing risks to governance and funding access. Despite these challenges, the company’s established infrastructure assets and strong cash flows provide a degree of stability. Argentina emerged as the standout performer among EM sovereign USD high-yield bonds. Newly elected President Javier Milei became the first foreign leader to meet with Trump, signaling strengthened bilateral relations. Fitch recently upgraded Argentina’s credit rating from CC to CCC, reflecting growing confidence in its ability to meet 2025 bond repayments without restructuring. Looking ahead, Romania’s first round of presidential elections this weekend could impact investor sentiment. The ruling centrist coalition, led by the Social Democratic Party and National Liberal Party, is expected to secure a majority, maintaining political stability and a pro-EU stance, which would support continued economic progress. While EM bonds are showing signs of stabilization, investors should remain attuned to risks stemming from policy shifts, leadership changes, and evolving economic conditions, which will shape the outlook for EM assets in the months ahead.
