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What happened last week?
In an interesting shift, Atlanta Fed President Raphael Bostic has become the first Federal Reserve official to openly suggest the possibility of pausing rate cuts. Bostic, typically not one of the Fed's more hawkish members, indicated he might support a pause in cuts if incoming data justifies it. His cautious stance reflects growing concerns over the balance between stimulating the economy and controlling inflation. However, other Fed officials remain confident in continuing the rate cut cycle. New York Fed President John Williams, Chicago Fed President Austan Goolsbee, and Richmond Fed President Thomas Barkin all expressed optimism that inflation is on a downward trajectory, even after September’s inflation report exceeded expectations. Their consensus is that inflation is steadily improving, allowing room for further cuts. On the more cautious side, Dallas Fed President Lorie Logan reiterated her call for a gradual approach to rate reductions. Despite favorable inflation data and a generally strong economic outlook, Logan highlighted potential risks, advocating for a measured path toward neutral interest rates. Her comments align with earlier concerns about inflation potentially rebounding and suggest a more careful approach moving forward. The market has slightly dialed back its expectations for aggressive cuts but still expects two more rate cuts by the end of the year, maintaining a generally dovish outlook. In Europe, attention now shifts to the ECB’s upcoming meeting, where the market anticipates a 25 basis point cut—the third of 2024. The ECB’s decision will likely hinge on recent weak economic data from the Eurozone, raising the question of whether they will accelerate the rate cut cycle to reach their terminal rate faster. Meanwhile, the Bank of England is expected to proceed with a rate cut in November, though there is uncertainty around a possible second cut in December. Finally, in Japan, the monetary policy outlook remains stable, with only a 30% chance of another rate hike by year-end, suggesting that Japan’s rates will likely stay unchanged for the remainder of 2024.
The corporate bond market experienced losses last week due to rising interest rates. However, credit spreads continued to tighten, signaling resilience. U.S. investment-grade (IG) spreads tightened by 2 bps to reach 81 bps, their lowest level since 2007, while high-yield (HY) spreads inched up to 294 bps. This tightening reflects the market's optimism regarding a potential soft landing for the U.S. economy, although some caution is emerging as investors hedge their portfolios. Evidence of this can be seen in the widening gap between cash and synthetic indexes. The CDX HY index, which tracks single CDS of high-yield issuers, remains around 328 bps, compared to 294 bps for the cash index, marking the highest positive basis in a year. In this context, the Vanguard USD Corporate Bond ETF posted a loss of -0.2%, while the iShares Broad USD High Yield Corporate Bond ETF saw a modest loss of -0.1%. In Europe, credit markets also showed tightening, with investment-grade spreads tightening to 109 bps, the lowest since July, and high-yield spreads narrowing to 348 bps, their tightest since mid-June. The iShares Core Euro IG Corporate Bond ETF registered a slight loss of -0.1%, while the iShares Euro HY Corporate Bond ETF gained +0.2%. The hybrid bond segment saw some profit-taking, as the Invesco Euro Corporate Hybrid ETF lost -0.3% last week, while bank subordinated bonds performed well, with the WisdomTree AT1 CoCo Bond ETF climbing +0.3%. This mixed performance highlights a cautious yet optimistic tone in the credit market as investors navigate rising interest rates and potential economic uncertainties.
Last week saw a significant shift in U.S. Treasury yields, with the 10-year U.S. Treasury yield ending the week at 4.1%, marking a 10-basis point increase and reaching its highest level since July. This rise was primarily driven by higher breakeven rates, which reflect the market’s inflation expectations. The 10-year breakeven rate surged to 2.33%, nearing its annual peak of 2.4%. Contributing factors to this upward movement include concerns over the Middle East conflict and its impact on oil prices, along with a slight upside surprise in U.S. CPI figures. These inflationary pressures have boosted market concerns, pushing breakeven rates higher. In this environment, U.S. government bonds faced losses. The iShares USD Treasuries ETF dropped 0.5% for the week, with the iShares 10-20 Year Treasury Bond ETF underperforming with a loss of -1.4%. Month-to-date, both ETFs are down -1.6% and -3.3%, respectively. Notably, the iShares USD 20 Year+ Treasury Bond ETF has slipped back into negative territory for the year, reflecting the pressure from rising long-term yields. On the positive side, inflation-linked bonds have shown resilience. The iShares USD TIPS ETF gained slightly (+0.1%) over the week, and year-to-date, it remains one of the best-performing segments of the U.S. Treasury market, up by 4%. If the recent rise in yields continues, we could see more investors extending their duration, as evidenced by the record sell-off in Treasury Bills and the first inflows into Treasury notes in three weeks, according to Bank of America data. Additionally, the MOVE index, which measures bond market volatility, surged back to its yearly highs, indicating increased uncertainty in interest rate expectations. In Europe, Fitch Ratings placed France's AA- rating under negative outlook late Friday, though this has not yet had a significant impact on French government bonds. The spread between 10-year French and German government bond yields has tightened slightly over the past 10 days. European government bonds also showed modest losses last week, with the iShares Core EUR Govt Bond ETF falling -0.2%, while the iShares EUR Inflation Linked Govt Bond ETF ended the week in positive territory, up +0.1%. Meanwhile, in the U.K., the 10-year government yield reached 4.23%, its highest level since early July, despite growing market anticipation for a second rate cut in November.
Emerging market
Emerging market (EM) bonds faced headwinds last week due to rising interest rates and a strengthening U.S. dollar. However, there was a positive development in EM sovereign bonds, where spreads narrowed to 275 bps, the lowest level since 2018. This tightening was partly driven by geopolitical tensions in the Middle East, which pushed oil prices to the $80 per barrel range—a development that, while not ideal, tends to benefit many oil-exporting EM countries. In this context, the iShares Emerging Market Sovereign Bonds ETF declined by -0.4%, while the iShares Emerging Market Corporate Bonds ETF lost -0.3%, and the VanEck J.P. Morgan EM Local Currency Bond ETF was down -0.1%. Despite these losses, primary market activity remained strong, reflecting solid investor demand. Issuance in the EM space has totaled $19 billion so far this month, bringing the year-to-date figure to over $340 billion, according to JPMorgan data. This robust issuance shows that investors are still interested in EM debt, even in a higher-rate environment. On the central bank front, Peru's central bank surprised the market by keeping its benchmark interest rate steady at 5.25%, pausing its previous rate-cutting cycle. This cautious stance was taken despite favorable inflation trends—headline inflation has fallen to 1.8% and core inflation to 2.6%. The bank cited concerns over potential inflation acceleration in the fourth quarter due to base effects as a reason for its pause. In Ghana, the country completed its debt restructuring by issuing five new bonds valued at $9.4 billion. Investors were given two options, including a discounted restructuring with a 37% haircut on the nominal value. Following this restructuring, Ghana re-entered the Emerging Market Sovereign Debt Index with a market value of $7.1 billion. In Colombia, Ecopetrol’s CEO, Ricardo Roa, is under investigation for alleged violations related to campaign spending limits during the 2022 presidential election. Roa, who managed President Gustavo Petro’s campaign, denies any wrongdoing and has the support of Ecopetrol's board. Due to the investigation, Ecopetrol withdrew its bond issuance last week but indicated it may revisit a potential transaction in the near future.
