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    Weekly fixed income review: February

    Weekly fixed income review: February

    24 February 2023 Fixed income
    Week to 24 February 2023
    • Federal Open Market Committee (FOMC) in broad consensus for slower rate hikes: A large majority of FOMC members voted for a 25 basis points (bp) increase in January, with only a few favoring a 50bp hike. While recent improvement in inflation may pave the way for a softer approach, the FOMC minutes showed it believes risks to inflation are skewed to the upside and that it would not consider lowering rates “until inflation is clearly on a path to 2%”. Although headline annual inflation has fallen, inflationary pressures have broadened, and policymakers fear they could remain persistent over the medium term if not fully addressed now. The 10-year US Treasury yield rose to approach 4% mid- week, a level that it had not reached since last November but ended at 3.86%. The two-year/10-year Treasury yield spread remained heavily inverted at approximately 80bp. Market forecasts for peak official rates have continued to edge higher, to approximately 5.4%, the highest level this cycle.

    • Municipal bond update.Munis underperformed Treasuries across the curve this week due to muni mutual fund outflows and rising bid-wanted lists. High grade muni yields increased by 18bp, 14bp, 10bp and 6bp in two-year, five-year, 10-year and 30-year maturities respectively. The muni curve is inverted at shorter maturities but remains steep at the long end. Ratios increased to 63% at two-years, to 64% at five-years, to 67% at 10-years and to 92% at 30-years. Per Lipper, open-end muni mutual funds and ETFs saw combined outflows of US$1.7bn. Ten-year tax-exempt yields are around 2.59% and 10-year taxable yields are around 4.90%.

    • Purchasing managers’ index (PMI) data recovers: Preliminary composite PMI figures from most major economies surprised to the upside for February. In the eurozone, the composite PMI rose to its highest level for nine months, reaching 52.3, two-points higher on the month. The UK enjoyed a similar bounce, with the composite PMI rising to 53.0 from 48.5, with both the manufacturing and services sectors contributing; the latter rose back above 50 (which separates expansion from contraction) for the first time in six months. Additionally, the ZEW’s Economic Sentiment Indicator for the eurozone rose to a one-year high (29.7), the second consecutive month in positive territory. While these figures suggest both the UK and the eurozone may avoid recession this year, they stoked fears that monetary policy may have to stay tighter for longer.

    • Market expectations for higher European Central Bank (ECB) interest rates: Swap markets are now pricing in ECB deposit rates reaching 3.75% later this year, from 2.5% currently. That would make it the highest level for official rates since 2001. ECB President, Christine Lagarde, said that policy makers were focused closely on wage inflation, concerned that rising wages would be passed on to consumers and keep upward pressure on inflation. Another ECB board member, Isabel Schnabel, said the risk is that inflation remains more persistent than markets currently anticipate.

    • Public finances in the UK show signs of improvement: The UK enjoyed a budget surplus of £5.4bn in January against consensus expectations of a £7bn deficit, underpinned by higher-than-expected tax receipts. This meant net borrowing was approximately £30bn lower than expected for the tax-year-to-date. Additionally, the fall in natural gas prices meant the government’s original estimate for its energy support package may be as much as £11bn too large, according to UK Treasury estimates.

    • Japanese inflation rises: Annual consumer inflation climbed to a new 41-year high of 4.3% in January owing mainly to higher imported raw material prices and the effects of the yen’s weakness. There is little difference between headline and core inflation (excluding fresh food prices) which increased 4.2%. The 10-year government bond yield continued to hover close to the 0.5% cap imposed by the Bank of Japan (BoJ). Many investors expect the BoJ to drop this policy once the newly elected governor takes office.

    • New Zealand hikes rates: The Reserve Bank of New Zealand raised its benchmark interest rate by a further 50bp, taking it to a 14-year high of 4.75%. Although the increase was in line with expectations, and was less than the 75bp hike in November, the central bank warned that further rate hikes could be expected. Inflation is currently sitting at a near 30-year high of 7.2%.

    Bloomber table 24-02-23

    Source: Bloomberg, 24 February 2023. Prices close of business 23 February 2023.

    Economic calendar

    27 Feb: US durable goods orders, EU economic sentiment.
    28 Feb: Japan retail sales and industrial production.
    01 Mar: US ISM Manufacturing PMI, Germany inflation and unemployment, UK BoE Governor policy statement.
    02 Mar: Eurozone inflation, Japan consumer confidence.
    03 Mar: Japan inflation, US ISM non-manufacturing PMI.

    Week to 17 February 2023
    • US CPI rises; Fed turns hawkish: Inflation prints for January reflected the fastest rise in US consumer prices in three months, increasing by 0.5% versus a rise of 0.1% in December. Resultantly, year-on-year (YoY) prices rose by 6.4%. The headline figure dashed hopes that the Federal Reserve would ease its rate hiking cycle, as inflation still looks resilient. Excluding food and energy, the CPI advanced 0.4% last month and rose by 5.6% YoY. Following the news, 10-year Treasury yields closed at a new high for 2023 of 3.90. Meanwhile, Cleveland Fed president Mester stated this week she “saw a compelling economic case for a 50 basis-point increase” at the Fed's most recent meeting, when it opted to hike by 25bp. Likewise, St Louis Fed President Bullard said he wouldn’t rule out supporting a 50bp hike in March, stating “it will be a long battle against inflation.” The Fed’s terminal rate is now forecast to be close to 6%.

    • Eurozone data reflects mixed economic performance: The euro area grew by 0.1%, while growth remained stable in the broader EU according to Eurostat’s flash estimate for seasonally adjusted Q4 GDP. Meanwhile, preliminary estimates of annual growth for 2022, indicated GDP increased by 3.5% in the euro area and by 3.6% in the EU as a whole. Less positively, eurozone industrial production fell more than expected in December, dropping by 1.1% and reversing November’s rise according to data released by Eurostat on Wednesday.

    • ECB reiterates further rate hikes in March meeting. In a speech on Wednesday, President Christine Lagarde reiterated that the European Central Bank intends to raise borrowing costs by another 50bp in its upcoming March meeting. “In view of the underlying inflation pressures we intend to raise interest rates by another 50 basis points at our next meeting in March,” Lagarde told European Union lawmakers in Strasbourg. It is widely anticipated that the upcoming increase is not going to be the last, and that the ECB is going to continue with several more rate hikes into 2023, driven by persistent underlying price pressures. Accordingly, the comments and the growing possibility of a more hawkish stance from the Fed drove bunds to hit an 11-year high on Thursday, while the 10yr bund yield hit a high of 2.53% on Thursday.

    • Japan posts weak Q4 growth. The Japanese economy grew by 1.1% in 2022 according to preliminary data from the Cabinet Office, reflecting growth for a second consecutive year but notably down from the rise of 2.1% seen in 2021. In nominal terms, the rise came to 1.3%, reflecting inflation stemming from rising fuel costs following Russia’s invasion of Ukraine and a weakening yen. On a quarterly basis, seasonally adjusted quarterly GDP rose by 0.2%, the first quarterly growth since Q2 2022. Household spending increased 0.5% in Q4, while corporate capital investment and private housing investment contracted by 0.5% and 0.1%, respectively.

    • Municipal bond update. Munis underperformed Treasuries across the curve this week after a prolonged period of outperformance.  High grade muni yields increased by 34 bp, 20 bp and 18 bp in 2, 5 and 10 year tenors, respectively. Rates increased 18 bp at the long end. The muni curve is inverted at 2-5 years and 2-10 years.  Open-end muni mutual funds experienced modest inflows, while ETFs posted outflows. The $9 billion new issue calendar faced challenges this week and received a poor reception apart from California deals. Several deals were pulled, downsized or cheapened to aid completion. Ten-year tax-exempt munis are now yielding around a 2.44% and 10-year taxable munis are yielding around a 4.85-4.90%.

    Bloomber table 17-02-23

    Source: Bloomberg, 17 February 2023. Prices close of business 16 February 2023.

    Economic calendar

    20 Feb: PBoC interest rate decision, prelim Feb eurozone consumer confidence, UK Rightmove house price index.
    21 Feb: Prelim France, Germany, UK, US, eurozone PMI Feb, Jibun Bank prelim Feb PMI Japan, Canada CPI, US existing home sales.
    22 Feb: Germany, Italy CPI Jan.
    23 Feb: Eurozone core HICP Jan, Japan CPI Jan, US initial jobless claims, prelim US Q4 GDP.
    24 Feb: German GDP Q4, France, Italy, eurozone consumer confidence Feb, US new home sales.

    Week to 10 February 2023
    • Peak US rate expectations rise. Jerome Powell stated in a speech in Washington during the week that the Federal Reserve expects headline inflation to continue to fall during the year and that the forces of “disinflation” were at work. However, he cautioned that this process would take some time. He also warned that interest rates would need to increase further and stay at high levels as the job market remains very tight (as demonstrated by last Friday’s non-farm payrolls for January). Several other Fed officials were vocal in supporting the narrative of keeping interest rates ‘higher for longer’ and market expectations for peak interest rates rose back above 5% and have stayed there this week. Bond yields rose gently over the week, with the 10-year Treasury yield up to 3.7%, its highest level for a month, before easing back a little.

    • EU inflation data better than expected. Annual German inflation touched 8.7% in January. Although this was higher than December’s 8.6%, inflation in December was suppressed by a one-off government energy subsidy to all households. On an EU-harmonized basis, German inflation actually fell to 9.2% from 9.6% in December, marking a five-month low. In the Netherlands, headline inflation fell to 7.6%, the lowest level for almost a year, as gas prices fell substantially. However, food price inflation continued to accelerate, hitting a record peak of 17.3% in the month, and core inflation (which excludes energy and food) edged higher from 6.2% to 6.4%.

    • Central banks raise rates. Reserve Bank of Australia (RBA) raised interest rates by 25bp to 3.35% and warned that rates would still need to head higher to control inflation in the country – which is at its highest level since 1990. It marked the ninth hike since last May and took Australian interest rates to their highest level since late 2012. Peak rate expectations rose to almost 4% following the hike and relatively hawkish commentary from the RBA. Meanwhile, the Reserve Bank of India (RBI) increased its repo rate by 25bp to 6.5%, as expected. This marked a slowdown from December’s 35bp hike and September’s 50bp hike. Inflation has recently fallen in India as food prices have eased, allowing the central bank to reduce its inflation forecast. However, the RBI suggested rates would still need to head higher as core inflation remains persistent. This message was echoed by the Swedish Riksbank, which raised rates by 50bp to 3.0%, with inflation above 10% in Sweden. It is also to speed up its sale of bond holdings to reduce the size of its balance sheet.

    • Municipal bond update. High grade tax-exempt muni yields increased by 15bp at the front end and 3bp to 7 bp for intermediate and long maturities, however they outperformed Treasuries across the curve.  The SIFMA Municipal Swap Index seven-day yield rose from 1.87% to 3.74% as investors switched out of previously rich tax-exempt money market funds to taxable funds forcing up dealer inventories of tax-exempt variable rate demand notes. Dealers raised yields significantly to try to bring back buyers. Both monthly and weekly reporting open-end muni mutual funds experienced inflows while ETFs continued to report outflows. The US$4.5bn calendar this past week was fairly well-received. Ten-year AAA rated tax-exempt munis are now yielding around 2.09% and 10-year AAA rated taxable munis are yielding around 4.40-4.50%.

    • UK narrowly avoids recession. UK GDP was flat in Q4 2022 according to preliminary data, thus avoiding a recession at a technical level. Year-on-year the economy grew by 0.4%. The National Institute of Economic and Social Research (NIESR) has forecast that the UK economy will eke out growth of 0.2% in 2023, before rising by 1% in 2024. These figures were revised down from previous estimates of 0.7% and 1.7% respectively. Falling inflation, especially lower gas prices, will come as a welcome relief to consumers and businesses although living standards will still be hit. The estimates from the NIESR distinguishes it from other recent major institutions’ forecasts, notably those from the Bank of England (BoE) and the IMF, which foresee the UK falling into recession in 2023. Gilt yields rose over the week, with the 10-year maturities up by approximately 30bp to 3.29%.

    Bloomber table 10-02-23

    Source: Bloomberg, 10 February 2023. Prices close of business 09 February 2023.

    Economic calendar

    13 Feb: Japan (flash) Q4 GDP.
    14 Feb: US CPI, UK unemployment and average wage growth, eurozone (final) Q4 GDP.
    15 Feb: UK CPI, PPI and RPI, eurozone industrial production, US retail sales.
    16 Feb: US housing starts, initial jobless claims, industrial production and PPI.
    17 Feb: UK retail sales, German PPI.

    Week to 03 February 2023
    • Federal Reserve slows pace of rate hikes again. As widely expected, the Fed funds rate increased by 25bp from 4.75%, its highest level for over 15 years. The hike marked a further reduction in the magnitude of rate increases, following a 75bp rise in November and a 50bp rise in December. Nevertheless, the accompanying statement from the Fed suggested the job was not yet complete, as inflation "has eased somewhat but remains elevated," and the market should expect further small-scale rate hikes. More reassuringly, Fed Chairman Jerome Powell later added that that "the disinflationary process has started", although he also warned, "I don't see us cutting rates this year". Currently, the market sees a terminal rate in the 4.75%-5.0% range and expects the Fed to cut rates before year-end. The US 10-year Treasury yield dropped 10bp on the news of the hike and ended the week lower.

    • The European Central Bank (ECB) raises interest rates by 50bp. The ECB increased its benchmark interest rate from 2.5% to 3.0% – a 15-year high. However, the tone of the accompanying statement was more hawkish than those of the Fed and the BoE, referring to inflation as “far too high”. Moreover, the ECB said that rates would need to rise further this year, with an explicit pledge of another 50bp hike at the March policy meeting. However, eurozone bond markets rallied, as the markets judged the central bank will base any future rates decision on the trajectory of inflation, which has potentially peaked. Thursday’s 20bp fall in the 10-year German Bund yield was the steepest for over a decade and the 10-year Italian government bond yield fell by almost 40bp on the day, as investors sense a peak in rates is not too far away.

    • The Bank of England (BoE) hikes interest rates by 50bp. The UK’s central bank hiked rates for the tenth consecutive time, taking the base rate from 3.5% to 4.0%, in line with expectations. Investors trained their focus on the commentary from the BoE’s Monetary Policy Committee suggesting inflation had most likely peaked and that the central bank could soften the pace of interest rate hikes going forward. The BoE also adjusted its forecasts and now expects GDP to fall 0.5% in 2023 (previously a fall of 1.5% was expected) and inflation to drop to 4% by the end of the year (previously 5.25%).

    • Overseas investors buy record levels of gilts in December. According to data from the BoE, overseas investors purchased a record amount of gilts in the final month of 2022, totaling £38.3bn. The relative underperformance of gilts against other global government bond markets during 2022, along with Rishi Sunak government’s well-received fiscal tightening plans, attracted overseas investors into the market.

    • Japan's central bank purchases a record amount of Japanese government bonds (JGBs) in January. 10-year JGBs tested the Bank of Japan's (BoJ) 0.5% yield cap during January, forcing the BoJ to purchase a record amount of JGBs, some $182bn, as part of its yield-curve control policy. The intervention followed its relaxation of the cap from 0.25% to 0.5% late last year and growing speculation that it will begin to pull back from its ultra-easy monetary approach, with inflation touching more than 30-year highs. As a result, the BoJ's JGB purchases surpassed the previous record set in June 2022 by approximately 45%.

    • High grade tax-exempt muni rallied this week but lagged Treasuries in the intermediate part of the curve though kept pace with governments on the long end. Ratios are still rich in 5 and 10 years at 57% and 63%, respectively, while the long-end muni ratio continues to stand at 88%. Open-end muni mutual funds experienced inflows while ETFs continued to report outflows. There was virtually no new issue supply this week. In the secondary, a high yield list garnered investor interest on Wednesday. Next week’s calendar is relatively small at approximately $4.5 billion and is virtually all tax-exempt issues. Ten-year AAA rated tax-exempt munis are now yielding around 2.13, while 10-year AAA rated taxable munis are yielding around 4.40-4.45 %.

    Bloomber table 03-02-23

    Source: Bloomberg, 03 February 2023. Prices close of business 02 February 2023.

    Economic calendar

    06 Feb: Eurozone retail sales and investor confidence, China trade balance.
    07 Feb: UK retail sales, US trade balance, Germany industrial production.
    08 Feb: Japan money supply.
    09 Feb: Japan PPI, US initial jobless claims.
    10 Feb: UK Q4 GDP, industrial production and trade balance, US consumer sentiment.

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