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    Weekly fixed income review: May

    Weekly fixed income review: May

    20 May 2022 Fixed income
    Week to 20 May 2022
    • UK inflationary pressures continue to build. Headline annual consumer price inflation (CPI) rose from 7.0% in March to a slightly lower-than-expected 9.0% in April (the highest rate in over 40 years), as core annual CPI increased from 5.7% to 6.2%, in line with expectations. Inflation is set to remain elevated and rise above 10%, due to the combined effects of the Russia-Ukraine war, higher energy prices and continued supply-chain constraints, which have been exacerbated by the lockdowns in China. Bank of England governor, Andrew Bailey, warned of an “apocalyptic” rise in food prices when he spoke to the House of Commons Treasury Committee. Meanwhile, the UK unemployment rate edged down from 3.8% to 3.7% in the three months to March, the lowest level for nearly 50 years. The 10-year gilt yield rose 12bp over the week, to 1.87%.

    • Concerns about a looming US recession. The 10-year Treasury yield rose at the start of the week as retail sales and industrial production in April both increased more than expected, rising 8.2% and 6.4% year on year, respectively. However, US retailers Target and Walmart then announced disappointing earnings as higher inflation weighed on consumers, leading to a sharp drop in the firms’ share prices and a fall in the 10-year Treasury yield. Against this backdrop, Federal Reserve chair Jerome Powell said the central bank was intent on raising interest rates, even beyond what is seen as a neutral level, until inflation returns to its 2% target. This has raised fears of a recession and equity volatility led to US corporate spreads being 7bp wider at 147bp. Cyclicals like GM and retailers following Target and Walmart’s earnings were major underperformers. New deals were at moderate levels with offerings from Citizens, UnitedHealth, Edison International, Nucor, and Westpac. Municipal bonds underperformed Treasuries over the week.

    • Stagflation risks in Europe rise. The European Commission now expects real GDP growth in both the EU and the euro area to be just 2.7% in 2022 (down from a previous forecast of 4%) and 2.3% in 2023. Inflation is expected to reach almost 7% later this year before falling back to around 3% in 2023. European Central Bank (ECB) policymaker and governor of the Bank of France Francois Villeroy de Galhau expressed concern that the euro’s recent weakness could make it harder for the central bank to meet its inflation target as import costs rise. Meanwhile, fellow ECB policymaker and Dutch central bank chief Klaas Knot said that the ECB may have to contemplate raising its policy rate by 50bps, rather than 25bps, at its July meeting. The 10-year German Bund yield was flat over the week at 0.95%.

    • Investors have become more risk averse, particularly towards European high yield bonds. So far this year, there has been $20bn of outflows, equating to 6% of assets under management, from European high yield retail funds (according to BoA, citing EPFR data). Meanwhile, Refinitiv says global high yield issuance is down 77% since the start of the year, with European volumes falling nearly 75% year on year. Based on ICE BofA index data, global corporate debt yields have risen almost 200bps on average in 2022, with those on euro-denominated high yield bonds doubling to 5.5%.

    • Inflation rises above Bank of Japan target. Headline annual CPI rose to 2.5% in April, while the core rate increased to 2.1%, taking it above the Bank of Japan’s 2% target for the first time in seven years. First-quarter GDP contracted 0.2% sequentially, given a challenging backdrop of record COVID-19 cases and higher energy costs. The 10-year JGB yield ended flat over the week, at 0.24%.

    • Concerns about the Chinese economy mount. The latest data showed that retail sales in April fell a worse-than-expected 11.1% year on year, having dropped 3.5% year on year in March, after widespread COVID-19 cases led to strict restrictions in several key states, including Shanghai and Beijing. Meanwhile, industrial production unexpectedly declined 2.9% year-on-year in April (having been forecast to rise slightly), which was the first fall since March 2020. China’s jobless rate rose to 6.1% in April, the highest level since February 2020. In response to the slowing economy, the People’s Bank of China cut its 5-year loan prime rate, which is used to price mortgages, by 15bps to 4.45% (the largest cut since 2019).

    Bloomberg table 20-5-22.svg

    Source: Bloomberg, 20 May 2022. Prices close of business 19 May 2022.

    Economic calendar

    23 May: Germany Ifo business climate indicator
    24 May: UK PMI, Japan PMI, eurozone PMI, US PMI, UK public sector net borrowing
    25 May: Germany consumer confidence, US durable goods orders, FOMC meeting minutes
    26 May: US Q1 GDP (2nd estimate), US initial jobless claims
    27 May: US personal income, US personal spending, US core PCE inflation, US Michigan consumer sentiment

    Week to 13 May 2022
    • Significant selling of global bonds seen across the world. According to data from Refinitiv Lipper, sales of global bond funds totalled $12bn in the week to 4 May (the last full week that the data is available), the fifth consecutive week of net selling, with most of the selling coming in US and European fixed income markets. Net sales of US bond funds hit $5.5bn in the week to 4 May, marking the seventeenth successive week of net selling. Investors remain concerned that the current backdrop of rising inflation and tightening monetary policy is not about to change. Indeed, during the week there were more calls from some former US policymakers for the Federal Reserve (Fed) to move quickly to bring inflation back under control. Former Fed vice chair Richard Clarida suggested that rates needed to get to at least 3.5% in order for inflation to be brought back towards the Fed’s target level of 2%, while current voting member Mester said that 75bp hikes couldn’t be ruled out forever.

    • Headline US annual inflation drops in April. There were tentative signs that US inflation may have peaked, as April’s inflation rate fell to 8.3% from March’s 41-year high, and the first monthly drop in the series since August last year. However, inflation for April alone was 0.3%, which, while down from March’s level, was still a little above the market’s expectations. The core consumer price index (which excludes energy and food prices) rose 0.6% over the month and by 6.2% year-on-year, also above market forecasts. US Treasury yields rose after the release of the inflation data, but over the week, the 10-year bond yield fell 28bp to 2.85%, having touched 3.2% on Monday, a three-and-a-half year high.

    • A UK think-tank predicts recession in the UK in the second half of this year. Following the Bank of England’s (BoE) surprise forecast of a fall in GDP in 2023, the National Institute of Economic and Social Research (NIESR) suggested that the UK was heading towards a recession earlier than the BoE’s prediction. In its opinion, a technical recession would occur in the second half of this year, with a quarterly fall of 0.2% in GDP over the third quarter, followed by one of 0.4% in the final quarter of 2022. This reflects the acute pressure on consumer incomes brought about by surging energy costs as well as the impact of higher taxation, namely the hike in National Insurance contributions. For 2023, the NIESR forecasts a rebound in GDP of 0.8%, better than the BoE’s expected decline of 0.25%, although this is revised down from growth of 1.3%. GDP for the first quarter rose 0.8% quarter on quarter, a little less than forecast and down from the previous quarter’s 1.3% growth rate. However, for March, the economy shrank 0.1% month-on-month, impacted by the growing cost-of-living crisis and the negative effects from Russia’s invasion of Ukraine.

    • UK policymaker calls for greater and quicker tightening from the BoE. Michael Saunders, who sits on the BoE’s Monetary Policy Committee and who was one of the three members recently voting for a 50bp rate hike, predicted that annual inflation is headed much higher and would likely peak above the central bank’s 10% forecast, made last week. In a speech during the week, he stated that he had high conviction that inflation would be higher and more entrenched than expected and that the BoE should “lean heavily” against it. The 10-year gilt yield rose above 2% early in the week, a level not seen since late 2015, before falling back below 1.7%.

    • Expectations of a rate hike by the European Central Bank (ECB) continue to rise. The market is beginning to look at the ECB’s next policy meeting on 9 June as a key date for getting more clarity on the timing of interest rate hikes in the eurozone. These are expected to come as early as July, once the bond-purchasing scheme is finally terminated. There were indications that ECB president Christine Lagarde had more formally acknowledged the need for tighter monetary policy. In a speech during the week, she appeared to become more definitive on timing, stating that a hike in rates could come in “a period of only a few weeks” after the ending of the asset-buying programme. However, she also stated that the pace of hikes would likely be gradual. Eurozone bond markets rallied towards the end of the week as investors appeared to favour the safety of bonds, particularly government bonds, over equities (which fell). The German Bund yield eased back below 0.9%, having risen towards 1.2% early in the week, a near eight-year high. The spread between Bunds and Italian government bonds (BTPs) also fell back below 200bp.

    Bloomberg table 13-5-22.svg

    Source: Bloomberg, 13 May 2022. Prices close of business 12 May 2022.

    Economic calendar

    16 May: Eurozone trade balance, China industrial production
    17 May: UK unemployment, US retail sales, US industrial production, Japan Q1 GDP
    18 May: UK CPI, PPI and RPI, US housing starts
    19 May: US initial jobless claims, Japan CPI, eurozone monetary policy minutes, UK consumer confidence
    20 May: UK retail sales, eurozone consumer confidence, German PPI

    Week to 6 May 2022
    • Biggest rise in US interest rates in 22 years. The Federal Reserve (Fed) increased the target range for its fed funds rate by 50 basis points (bp) to 0.75%-1.0%, the first increase greater than 25bp since May 2000, as inflation has continued to rise. Fed chairman Jerome Powell stated that inflation was “much too high” and that further 50bp hikes could be expected at the next policy meetings in June and July. However, while Powell reassured markets that a 75bp hike was not currently being “actively” considered, the futures market seems less convinced and is pricing in a 75% chance of that happening in June. Additionally, the Fed said it would begin to pay down a net $47.5bn in government debt each month over June, July and August, and then $97bn per month from September, as it begins to reduce its balance sheet. The 10-year Treasury bond yield climbed above 3% early in the week, for the first time since late 2018. The two-year/10-year yield curve spread has steepened to approximately 35bp. Meanwhile, the yield on 10-year Treasury Inflation-Protected Securities moved above zero, to around 0.2%, for the first time in just over two years.

    • High yield bonds fall to a two-year low. With interest rates rising in the US, the high yield market has suffered. The yield on the Bloomberg US corporate high yield index rose to over 7% during the week, for the first time since May 2020, with the market’s spread over the 10-year Treasury bond yield rose above 400bp. The euro high yield market presents a similar picture, with the effective yield of the Bloomberg Pan-European high yield index now above 6%, having been below 3% as recently as September 2021.

    • Inflationary pressures in the euro area continue to escalate. The eurozone’s annual producer price inflation rate hit a new all-time high of 36.8% in March, ahead of market expectations, and up from February’s figure of 31.5%. Energy prices surged by over 100% year on year and were the main factor behind the rise in the headline figure. The release of the data coincided with more calls from senior policymakers at the European Central Bank for rate hikes this year, with the Austrian central bank governor, Robert Holzmann, stating that he belonged “to the group that is now in favour of rapid action”. The 10-year Bund yield rose above 1% for the first time since May 2015, while the yield spread between 10-year Bunds and 10-year Italian BTPs rose towards 200bp, the highest for almost two years.

    • The Bank of England (BoE) tightens monetary policy with a further interest rate hike. As largely expected, the BoE raised its Bank Rate for the fourth successive time, by 25bp, taking it to 1%, the highest level since the latter part of the Global Financial Crisis in 2009. While there had been calls from some quarters for a 50bp hike (and three policy committee members voted for that), the BoE erred on the side of caution, recognising that, although inflation is very high, the economy is also increasingly fragile. The BoE now expects inflation to continue rising, reaching a peak of 10% later in 2022. A report earlier in the week from the British Retail Consortium revealed that household goods (non-food) inflation was running at its highest level since the data series started in 2006, rising 2.2% in April alone. Additionally, the UK manufacturers’ purchasing managers index showed that nearly 85% of UK manufacturers faced increased purchasing costs in April, with none reporting decreases, reflecting the inflationary pressure in the economy.

    • Both the Reserve Bank of Australia (RBA) and the Reserve Bank of India (RBI) begin to tighten monetary policy. The RBA raised interest rates for the first time since 2010, increasing its cash rate by 25bp to 0.35%, more than had been expected. It also signalled further rate hikes ahead as it tries to keep a lid on annual inflation, which hit a more than 20-year high of 5.1% in the first quarter of 2022. In India, the RBI unexpectedly increased its repo rate from 4.0% to 4.4%, the first hike since mid-2018, in an effort to control an inflation level that almost hit 7% in March, above its 2%-6% target range.

    Bloomberg table 06-5-22.svg

    Source: Bloomberg, 06 May, 2022. Prices close of business 05 May, 2022.

    Economic calendar

    09 May: China trade balance, eurozone investor confidence
    10 May: UK retail sales, eurozone economic sentiment
    11 May: US CPI, Germany CPI, China CPI and PPI, Japan leading economic index
    12 May: UK GDP, UK industrial production, UK trade balance, US PPI, US initial jobless claims
    13 May: Eurozone industrial production, US consumer sentiment

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