Weekly fixed income review

Week to 05 August 2022

  • The Bank of England’s Monetary Policy Committee (MPC) meeting concluded with a 50bp rate hike, taking the policy rate to 1.75%. The MPC warned that CPI is expected to peak later in the year above 13% and forecasts the economy will enter a prolonged recession in late 2022 lasting until late 2023. Previously, forecasts in May indicated an inflation peak of around 11%, but energy prices are set to rise even more than expected. Meanwhile, domestic pressures are building as businesses try to pass on rising costs to protect margins, while a shortage of workers is stoking wage inflation in some sectors. Breakeven rates rose by more than 6bp in response to warnings of even higher inflation, while 2s10s briefly inverted as the market reflected on the MPC’s warnings of an imminent, protracted recession.

  • UK activity continues to lose momentum even as the MPC raised rates. The final estimate for the composite PMI in July was 52.1, a drop from 53.7 in June and below the flash reading of 52.8. This indicated the slowest rate of expansion since February 2021 with new orders increasing only marginally on soft demand both domestically and overseas.

  • Core Eurozone yields materially outperform US equivalents as growth concerns intensified. 10-year Bund yields initially drifted higher after a recent strong rally during which yields tightened by 50bp in a fortnight. However, the sell-off was much less pronounced than the US, as very weak data cast fresh doubts on the economic strength of the Eurozone. Retail sales fell sharply in June while factory gate prices continued to rise, adding to fears of recession and central bank policy tightening to combat rising prices even as activity slows sharply. By the end of the week, yields tightened as economic concerns mounted.

  • In the US, the sizeable drop in yields that followed the Federal Open Market Committee (FOMC) meeting has now largely reversed. Several hawkish comments from Fed members Daly (the fight against inflation is “nowhere near done”), Mester (monthly inflation “hasn’t even stabilised yet”) and Bullard (expects the Fed to have to keep hiking to combat inflation but is confident the economy can avoid a recession) undermined the market’s hopes for some moderation in monetary policy over the coming months. Market expectations for the terminal Fed policy rate, anticipated in early 2023, crept upwards to 3.50%. Meanwhile, 10-year US Treasury yields widened to just below 2.70% by Thursday’s close, reversing some tightening witnessed earlier in the week.

  • Municipal bond funds reported robust inflows on a combined basis of $1.6 billion. All municipal fund categories experienced inflows except for tax-exempt money market funds as investors repositioned into longer dated and higher yielding products. AAA rated tax exempt yields fell 3 to 4 basis points except at the front end, which was flat. New deals were well received though bid-wanted pressure increased in the secondary as the week progressed and street sentiment waned. Ten-year AAA rated tax-exempt municipal yields reached 2.18%, and 10-year AAA rated taxable municipal yields reached 3.55%.

  • Chinese manufacturing PMI data was weaker than expected in July. The index dipped from 51.7 in June to 50.4 last month, against expectations of 51.5. The drop reflected the impact of widespread COVID-19 lockdowns and a shortage of electricity at some firms. Input and output prices eased, which is reassuring for inflation worries but symptomatic of softer demand.

  • Another wave of COVID-19 infections is placing Japan’s health system under pressure. While the dominant sub-variant is generally considered less severe than earlier strains, the sheer number of infections is causing serious problems for parts of the healthcare system. In late July, occupancy rates for beds set aside for Covid patients were above 50% in 15 prefectures.

Bloomberg table 05-8-22

Source: Bloomberg, 05 August 2022. Prices close of business 04 August 2022.

Economic calendar

08 August: Japan current account
09 August: UK BRC retail sales, US unit labour costs, US nonfarm productivity, US API crude oil stock change
10 August: China inflation, Germany inflation, US inflation, US wholesale inventories
11 August: UK RICS house price balance, US PPI, US initial jobless claims
12 August: UK preliminary Q2 GDP, UK manufacturing & industrial production, Eurozone industrial production, US Michigan consumer sentiment

Important information

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