.png)
What happened last week?
BoE’s Dovish Shift, ECB Steady, and the Fed Holds Firm Amid Strong U.S. Data!
Last week, the Bank of England (BoE) took center stage, cutting its key rate by 25bps to 4.50%, as widely expected. However, the communication surrounding the decision leaned dovish, with two of nine MPC members voting for a more aggressive 50bps cut. The BoE also downgraded GDP growth forecasts, reflecting persistent economic weakness. Yet, inflation remains stubborn, particularly in wages and services, forcing the central bank into a stagflationary dilemma. The BoE now expects 2025 inflation at 3.5% (vs. 2.8% prior)—well above target—making further rate cuts highly dependent on inflation easing in the months ahead. Markets are pricing 25bp cuts at the May and August meetings, but beyond summer, rate expectations remain uncertain, with only a 45% probability of another cut in Q4 as inflation risks linger. In the Eurozone, disinflation is progressing more clearly due to weak economic growth, though rising energy prices could trigger a temporary inflation uptick in spring. Several ECB policymakers voiced confidence that inflation will soon hit the 2% target, reinforcing the outlook for continued rate cuts. The ECB released research suggesting that the neutral rate is between 1.75%-2.25%, aligning with market expectations that the Deposit Rate will be lowered to 1.75% by year-end. With at least three, potentially four, 25bp cuts ahead, markets remain steady in their ECB outlook. Meanwhile, U.S. economic data remains resilient, reinforcing the Federal Reserve’s cautious stance. The Unemployment Rate fell to 4%, the lowest since May 2024, while wages saw their strongest monthly increase in five months (+4.1% YoY). These factors confirm the Fed’s January message: no urgency to cut rates. Rate cut expectations rose midweek after a weak ISM Services report and Treasury Secretary Scott Bessent’s comments on energy prices, but reversed as markets absorbed stronger labor data. Futures now price -40bps of cuts by year-end, with a July rate cut fully priced in and a 60% chance of another by December. These moves highlight a divergence in monetary policy paths, as EM central banks front-load easing while the Fed, ECB, and BoE navigate a far more complex inflation landscape.
Resilience Amid Tariff Volatility, High-Yield Outperforms.
Despite tariff-related volatility, credit markets remained remarkably stable, with only a few tariff-sensitive sectors, such as European autos and retail, underperforming within EUR investment grade (IG). In contrast, U.S. IG autos, retail, and consumer products credit remained resilient, with spreads holding firm both in absolute terms and relative to their equity counterparts. While tariffs will inevitably impact corporate earnings in specific industries, their effects tend to materialize faster in equity valuations than in credit spreads. Companies often absorb tariff-related costs through currency adjustments, supply chain shifts, and strategic pricing, mitigating immediate risks to credit fundamentals. However, sector dispersion is set to rise, with greater volatility in credit spreads for companies directly exposed to higher import costs. A notable example is S&P’s negative outlook on Ford, which highlights the unintended consequences of Trump’s tariff policies on domestic manufacturers. Ford, despite producing fewer vehicles in Mexico than GM, relies heavily on imported auto parts, a key vulnerability given that some components cross the U.S.–Mexico border up to seven times during assembly. This underscores the potential long-term supply chain disruptions that tariffs could impose. Despite these concerns, U.S. investment-grade credit remained resilient, with the Vanguard USD Corporate Bond ETF rising +0.1% for the week, extending its +0.5% gain from the previous week. High yield (HY) outperformed, as U.S. HY spreads tightened by 1bp to 267bps, marking a 25bps compression year-to-date. The iShares Broad USD High Yield Corporate Bond ETF continued its strong performance, up +1.4% year-to-date. In Europe, credit markets also showed stability, with EUR IG spreads widening by just 1bp to 91bps, still 10bps tighter year-to-date. Euro HY spreads tightened further by 6bps to 296bps, reflecting strong demand despite market turbulence. The iShares Core Euro IG Corporate Bond ETF rose modestly, adding to its +1.0% gain from the previous week, while the iShares Euro HY Corporate Bond ETF advanced +0.1%, supported by light new bond issuance. High-beta credit continued to outperform, with the WisdomTree AT1 CoCo ETF climbing +0.5% for the week (+1.7% year-to-date) and European corporate hybrids gaining +0.9% (+1.2% year-to-date). While tariff-driven equity volatility has dominated headlines, its impact on credit remains measured, though spread dispersion is expected to rise as companies navigate longer-term earnings and supply chain pressures. Investors should stay alert to sector-specific risks, particularly in autos, industrials, and consumer goods, as trade tensions evolve.
Treasury Rally Strengthens Amid Tariff Concerns, While JGBs Hit 14-Year Highs!
Government bonds extended their rally last week, with long-duration bonds outperforming while the front end remained flat. The iShares USD Treasuries ETF gained +0.3%, as the iShares 10-20 Year Treasury Bond ETF surged +1.5%, while shorter maturities lagged, with the iShares 3-7 Year Treasury Bond ETF unchanged. The move was driven primarily by tariff fears, which have already impacted inflation expectations, now soaring above 3% for the first time in two years. Meanwhile, mixed U.S. economic data weighed on longer-end yields, with the U.S. economic surprise index dropping to zero, reinforcing concerns over growth. As a result, the U.S. yield curve flattened by 13bps to 20bps, signaling a shift in market sentiment. The 10-year U.S. Treasury yield ended the week at 4.50%, down 4bps from the previous week, reflecting investor demand for safe-haven assets amid rising geopolitical and economic uncertainty. In Europe, inflation data took center stage as Eurozone CPI unexpectedly rose to 2.5% in January (from 2.4% in December), keeping the core inflation rate elevated at 2.7%. While services inflation dipped slightly to 3.9% from 4%, ECB President Christine Lagarde dismissed concerns, attributing the uptick to base effects from energy prices. However, the ECB’s main wage growth indicator signaled a sharp slowdown ahead, bolstering confidence that inflation will ease further, keeping the door open for rate cuts. European government bonds responded positively, with the iShares Core EUR Govt Bond ETF gaining +0.7% last week. In the UK, gilts rallied on the BoE’s rate cut, pushing the Vanguard U.K. Gilt ETF up +0.7%, extending its year-to-date gains to +1.7%. However, the worst performer of the week was Japanese bonds, as yields climbed further. The 10-year JGB yield breached 1.30% for the first time since 2011, reflecting persistent inflation pressures and the BoJ’s tightening stance. The iShares Core JP Government Bond ETF lost -0.5%, marking another challenging week for Japan’s fixed income market. With tariff-driven inflation fears escalating and global monetary policies diverging, volatility in rates remains high. Investors are watching closely as inflation expectations continue to rise, pressuring central banks to carefully navigate their next moves.
Emerging market
Rate Cuts Accelerate, Credit Spreads Hit Cycle Lows.
Emerging market (EM) bonds continued their strong run last week, supported by falling U.S. interest rates, a resilient global economy, and accelerated monetary easing across key EM central banks. The Reserve Bank of India cut its benchmark rate by 25bps to 6.25%, while Banco de México lowered its key rate by 50bps to 9.50%, citing slowing inflation and rising U.S. trade tensions. EM hard currency bonds benefited from both spread tightening and rate-driven duration gains. The iShares Emerging Market Sovereign Bonds ETF climbed +0.6% for the week, as spreads narrowed by 8bps to a new cycle low of 234bps. EM corporate bonds also outperformed, with the iShares Emerging Market Corporate Bonds ETF rising +0.3%, supported by a 4bps tightening in spreads to 205bps. Notably, Asian high-yield debt surged, with the iShares USD Asia High Yield Bond ETF up +1%, despite the 10% tariff on Chinese goods imposed by the Trump administration. This suggests that investors remain confident in the region's ability to absorb the economic impact of new trade restrictions. Overall, EM credit continues to benefit from improving global liquidity conditions, with central banks in India and Mexico leading the way in monetary easing. However, rising geopolitical risks and trade tensions remain key factors to monitor, as the next phase of U.S. tariff policies could impact export-driven EM economies.
