Weekly fixed income review

Week to 21 January 2022

  • Inflation fears hit markets, causing a sell-off in both bond and equity markets. Global bond and equity markets retreated as they adjusted to the prospect of more immediate and greater monetary tightening than previously expected. Tight supply conditions for oil were exacerbated by an attack by Yemeni rebels on oil facilities in the United Arab Emirates, which darkened investors’ moods further; Brent crude hit a more than seven-year high of approximately $89 per barrel. The US dollar strengthened on expectations that the US Federal Reserve (Fed) would soon move to raise rates (with March now seen as a certainty according to Fed funds futures) and as investors sought out safer currency holdings as geopolitical uncertainties resurfaced. The US 10-year Treasury yield rose to its highest level in just over two years, climbing towards 1.90%, before falling back. Yields on short-dated bonds also increased, with that on two-year Treasuries topping 1%. Moreover, bond yields increased across the world. The 10-year German Bund yield rose back into positive territory during the week, hitting 0.1%, its highest level – and the first time it had been above 0% – since the spring of 2019.

  • UK inflation soars. The annual consumer price index rose 5.4% year on year, ahead of market forecasts and up from November’s 5.1% rate. Rising food, petrol and household energy costs drove the headline figure higher. Expectations have grown that headline inflation could hit 7% in April. Meanwhile, core inflation, which excludes energy and food prices, also jumped 4.2% on an annual basis, up from 4.0% in the previous month. The market now fully expects a further rate hike from the Bank of England following February’s Monetary Policy Committee meeting. The 10-year gilt yield rose above 1.2%, the highest level since February 2019.

  • Eurozone inflation marked a new high level. Annual inflation in the euro area (according to preliminary figures) increased to 5.0% in December, a new high, up from 4.9% in November and just 0.9% in January 2021. Despite the rising headline inflation rate, the European Central Bank (ECB) is not expected to alter its current relatively loose monetary policy. Indeed, ECB President Christine Lagarde commented during the week that the ECB had “every reason to not react as quickly” as the Fed. This stance has seen the yield spread between two-year US and German bonds rise to over 160bp, the highest level since the pandemic began.

  • China cut rates during the week. The People’s Bank of China cut the rate on both its one-year medium-term lending facility to banks and its one-year and five-year loan prime rates by between 5-10bp, as concerns about the pace of domestic growth and debt issues within the local property market deepened. Fourth-quarter GDP rose 4.0% year on year and although this was slightly above market predictions, it marked the weakest growth rate for six quarters. It was the first cut in the medium-term loan prime rate since April 2020. The move follows recent reductions in short-term rates and banks’ reserve requirement ratios. The market expects further rate cuts from the central bank in the coming months.

Chart of the Week: The US 10-year Treasury yield rose to its highest level in nearly two years (%)

Chart of the Week: The US 10-year Treasury yield rose to its highest level in nearly two years (%)

Source: Bloomberg. Data as at 21 January 2022.

Bond spreads (over govts) Week-to-date change (bp)
Bloomberg US Corporate Index 98bp +2
Bloomberg Euro Corporate Index 99bp +1
Bloomberg Sterling Non Gilts Index 95bp +1
Bloomberg US Corporate High Yield Index 298bp +5
Bloomberg Pan-European High Yield Index 315bp +10
Bond yields (10yr)
USA 1.80% +2
Germany -0.02% +2
Japan 0.15% +0
UK 1.23% +8
Equities Week-to-date change
S&P 500 4,483 -3.9%
DJ Euro Stoxx 50 4,300 0.6%
FTSE 100 7,585 0.6%
DAX 15,912 0.2%
Nikkei 225 27,773 -1.2%
Currencies
EUR/USD 1.13 -0.9%
JPY/USD 114.11 0.1%
GBP/USD 1.36 -0.5%
Commodities
Brent Crude ($ per barrel) 88.38 +2.7%
WTI Crude ($ per barrel) 86.90 +3.7%
Gold ($ per ounce) 1,839.29 +1.2%

Source: Bloomberg, 21 January 2022. Prices close of business 20 January 2022.

Economic calendar

24 January: US, UK and eurozone (preliminary) composite PMI
25 January: US housing prices, German IFO business climate
26 January: Japan leading economic index, US trade balance
27 January: US Q4 GDP, US durable goods orders, US initial jobless claims, Japan CPI
28 January: Eurozone economic sentiment, US Michigan consumer sentiment

Important information

The value of investments and any income from them will fluctuate and is not guaranteed (this may be partly due to exchange rate fluctuations). Investors may not get back the full amount invested. Past performance is not a guide to future performance.

Investments in bonds are affected by interest rates and inflation trends which may affect the value of the portfolio.

Where the portfolio holds over 35% of its net asset value in securities of one governmental issuer, the value of the portfolio may be profoundly affected if one or more of these issuers fails to meet its obligations or suffers a ratings downgrade. 

A credit default swap (CDS) provides a measure of protection against defaults of debt issuers but there is no assurance their use will be effective or will have the desired result.

The issuer of a debt security may not pay income or repay capital to the bondholder when due.

Derivatives may be used to generate returns as well as to reduce costs and/or the overall risk of the portfolio. Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment.

Investments in emerging markets can be less liquid and riskier than more developed markets and difficulties in accounting, dealing, settlement and custody may arise.

Where high yield instruments are held, their low credit rating indicates a greater risk of default, which would affect the value of the portfolio.

The investment manager may invest in instruments which can be difficult to sell when markets are stressed.

Where leverage is used as part of the management of the portfolio through the use of swaps and other derivative instruments, this can increase the overall volatility. While leverage presents opportunities for increasing total returns, it has the effect of potentially increasing losses as well. Any event that adversely affects the value of an investment would be magnified to the extent that leverage is employed by the portfolio. Any losses would therefore be greater than if leverage were not employed.

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