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What happened last week?
Inflation Relief Fuels Dovish Fed Hopes, While BoJ Signals a Hawkish Shift!
Last week brought some relief to the Federal Reserve as a set of balanced U.S. economic data eased market concerns over inflation and reignited optimism for monetary easing in 2025. Both CPI and PPI inflation reports for December came in slightly below expectations, reducing fears of a runaway inflationary rebound. This favorable backdrop allowed dovish-leaning comments from Governor Christopher Waller to capture attention. Waller suggested that rate cuts might occur “sooner than maybe the markets are pricing in” and hinted at the possibility of more rate cuts in 2025 than previously anticipated. He even left the door open for a potential cut as early as March, though a status quo at the January 29th meeting is widely expected. Waller further suggested that 3 or 4 rate cuts could be on the table this year if the data “cooperate,” a notable shift from the two cuts projected at December's FOMC meeting. The combination of softer inflation data and Waller’s remarks prompted a reversal of the prior week’s repricing in futures markets. By the end of the week, rate cut expectations for 2025 were back to -40bps, restoring the pre-Employment Report levels. Elsewhere, Scott Bessent, during his Senate hearing for confirmation as the next U.S. Treasury Secretary, sought to reassure markets regarding monetary policy independence. His statement that “on monetary policy decisions, the FOMC should be independent” eased concerns about potential interventionism under the Trump administration, offering an additional layer of calm for the Fed’s outlook. Across the Atlantic, there were no major updates from the ECB, with markets continuing to price in -100bps of cuts by year-end. In the United Kingdom, softer-than-expected inflation and economic activity data helped defuse mounting tensions in rates markets. A 25bp rate cut at the Bank of England’s next meeting on February 2nd is now nearly fully priced (up from a 75% probability the prior week), with total cuts expected by the end of 2025 rising to -66bps from -47bps a week ago. Meanwhile, in Japan, Bank of Japan (BoJ) Governor Kazuo Ueda and Deputy Governor Ryozo Himino indicated a potential rate hike at the upcoming January 24th meeting, barring any significant market disruptions driven by U.S. political developments. As a result, markets adjusted upward, pricing in nearly a full 25bp hike (+23bps expected, up from +14bps the week prior). These comments further underscore the BoJ’s cautious but steady shift toward normalization, even as global uncertainties loom.
Resilient Rebound Amid Persistent Volatility.
Credit markets have made a robust recovery just two weeks into 2025, bouncing back sharply from early-year jitters. The credit market landscape remains defined by solid corporate fundamentals, strong technical demand, and relatively tight spreads, though elevated valuations and persistent volatility present challenges. Investor confidence remains strong, with significant fund inflows into U.S. and European investment-grade (IG) and U.S. high-yield (HY) bonds. European HY saw minor outflows, while the European money market recorded a notable dip, reflecting heightened rate cut expectations from the ECB. The combination of supportive demand dynamics and heavy new bond issuance continues to fuel momentum, but looming policy uncertainties and potential earnings pressures could drive wider dispersion in spreads among issuers. In the U.S., corporate bonds have demonstrated remarkable resilience amid a volatile Treasury market. The Vanguard USD Corporate Bond ETF (6.6-year duration) rose +1% last week, nearly erasing prior losses. Shorter-duration assets performed even better, with the iShares Broad USD High Yield Corporate Bond ETF (3.4-year duration) gaining +1.3% last week, bringing its year-to-date return to +1.1%. High-yield corporates stand to benefit further from Trump’s proposed reversal of the tax deductibility cap on corporate interest expenses, moving from 30% of EBIT to 30% of EBITDA, a move particularly advantageous for leveraged HY issuers. In Europe, corporate bonds also staged a recovery, with the iShares Core Euro IG Corporate Bond ETF (4.3-year duration) gaining +0.3% and the iShares Euro HY Corporate Bond ETF (2.3-year duration) advancing +0.6%, fully recovering the prior week’s losses. The iTraxx Xover index, a barometer of European high-yield credit risk, narrowed by 22bps, signaling reduced stress in higher-beta credit segments. Subordinated debt joined the rally, with the WisdomTree AT1 CoCo Bond ETF up +1% last week, bringing its year-to-date performance into positive territory at +0.4%. Despite encouraging signs of resilience, the credit market is poised for ongoing volatility as Trump tariff policy and inflation data evolve.A Strong Week for Government Bonds as Inflation Data Provides Relief.
Global bond markets rebounded sharply last week, buoyed by reassuring inflation data and signs of moderating wage growth. This provided much-needed relief to investors after a challenging start to the year. In the U.S., Treasury yields declined across the curve, with the 10-year yield ending the week at 4.62%, 13 basis points lower than the previous week but still above its 2024 close. The decline was primarily driven by an increase in Fed rate cut expectations, which helped the belly of the curve (5-7 years) outperform. The rally was reflected in the performance of bond ETFs: the iShares USD Treasuries ETF rose +0.8%, while the iShares 10-20 Year Treasury Bond ETF gained an impressive +1.6%. Meanwhile, the iShares 20+ Year Treasury Bond ETF saw record-high short interest, accompanied by substantial outflows, suggesting potential for a short squeeze. Notably, call option volumes on the ETF hit their second-highest level in history last Wednesday, indicating heightened speculation of a bond rally. Across the Atlantic, UK gilts surged on softer inflation and growth data. The 10-year Gilt yield fell almost 20bps to 4.66%, with the 2-year Gilt yield also dropping to 4.37%. The high duration profile of UK gilts made them standout performers, with the iShares Core UK Gilts ETF gaining +1.5%, the best performance among peers. In the Eurozone, bonds joined the rally, albeit to a lesser extent. The 10-year German Bund yield declined by 6bps to 2.53% but remains nearly 20bps higher year-to-date. The iShares Core EUR Govt Bond ETF rose +0.65% for the week but is still down -0.9% YTD. French and peripheral spreads narrowed, with the 10-year yield spread between France and Germany closing at 77bps (-5bps), its tightest weekly close since early December. This narrowing reflects market confidence in the Bayrou government’s ability to stabilize fiscal policy. In Japan, yields surged on speculation of a Bank of Japan (BOJ) policy shift. The 10-year Japanese yield hit 1.26%, its highest level since April, while the 2-year yield reached 0.7%, a 15-year high. Anticipation is building around a potential BOJ rate hike at its upcoming meeting, driven by signals from Governor Kazuo Ueda and Deputy Governor Ryozo Himino. With sustained wage growth and inflation, markets are pricing in a potential increase in the BOJ's short-term policy rate from 0.25% to 0.5%. Overall, last week highlighted the sensitivity of global bond markets to inflation trends and central bank signals, setting the stage for continued volatility in the weeks ahead.
Emerging market
Riding the Wave of Global Rates Rally Amid Local Dynamics.
Emerging market (EM) bonds were clear beneficiaries of last week’s global bond market rebound, as easing U.S. rates provided a supportive backdrop. Despite a slight widening in EM credit spreads—corporate spreads increased by 6bps to 211bps and sovereign spreads by 5bps to 248bps—the drop in U.S. interest rates enabled EM bond indexes to post strong positive performances. The iShares Emerging Market Sovereign Bonds ETF gained +1.2% over the week, while the iShares Emerging Market Corporate Bonds ETF added +0.7%. Latin America remained a standout performer, led by Brazil and Mexico. Brazil’s 5-year CDS tightened by 7bps to 188bps last week, marking a 30bps improvement year-to-date as fiscal and monetary dynamics remain favorable. Mexico also posted solid gains, with its 5-year CDS narrowing by 3bps to 127bps, adding to a year-to-date improvement of 15bps. These moves highlight continued investor confidence in the region’s economic resilience and proactive policy measures. In Asia, China faced a different set of challenges, grappling with significant liquidity pressures ahead of the Lunar New Year. To address a cash squeeze exacerbated by tax payments, maturing lending facilities, and seasonal cash demands, the People's Bank of China (PBoC) conducted two massive liquidity injections last week. On Wednesday, the PBoC carried out its second-largest short-term repo operation ever, injecting a net CNY 958.4 billion (USD 131 billion). This was followed on Thursday by an additional CNY 336.4 billion (USD 46 billion) injection. These measures were necessary to counterbalance liquidity outflows and stabilize the interbank funding market, where the 7-day repo rate had spiked from 1.56% on January 7th to a nearly two-year high of 2.34% by January 16th. After the second injection, funding rates eased to 2.12%, underscoring the temporary relief provided by these operations. Looking ahead, while the global rates environment remains supportive, EM markets face ongoing challenges, including localized economic and liquidity pressures. However, resilient sovereign fundamentals in countries like Brazil and Mexico, combined with decisive policy responses from key players such as the PBoC, continue to underscore the diverse opportunities in the EM space. This resilience amidst volatility positions EM debt as a compelling opportunity for 2025.
