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    Weekly fixed income review: July

    Weekly fixed income review: July

    July 29, 2022 Fixed income
    Week to July 29, 2022
    • The US Federal Reserve increased the Fed funds rate by 75bp for the second successive month. The rate has now reached 2.25-2.50%, a level that some members of the Federal Open Market Committee believe is close to neutral. Interest rate futures are pricing in a terminal rate in the region of 3.3%. Incremental hikes are expected through the rest of the year, but at a slower pace as growth concerns intensify. The Fed announcement coincided with news that the US had recorded a second successive quarter of negative GDP growth (-0.9% annualized in the three months to July). These figures maybe revised in coming weeks and as such Fed Chair, Jerome Powell, stated, in a press conference following the rate rise announcement, that as such he did not believe the US economy was in recession. New issuance over the week was muted given the Fed meeting but GM, Appalachian Power, and Kinder Morgan issued.

    • The International Monetary Fund (IMF) cuts global growth forecasts. The IMF expects global real GDP growth in 2022 of just 3.2%, down from its forecast of 3.6% in April. It also cut its 2023 GDP forecast to 2.9% from 3.6% in April over concern at the consequence of widespread monetary policy tightening on economic activity.

    • Municipal bonds see first inflows since January. Muni funds reported inflows on a combined basis for the first time since January 2022. AAA-rated tax-exempt short and intermediate-term muni yields fell 10 to 16bp. Notable inflows were experienced by high yield and long-term funds along with ETFs; 10-year AAA-rated tax-exempt munis are now yielding a 2.23% and 10-year AAA-rated taxable munis are yielding a 3.55%.

    • Bund yields see sharp decline. European natural gas futures prices surged to fresh recent highs in mid-week above EUR 200 / MWh, exacerbating concerns about European economic prospects heading into the winter months as the possibility of rationing and the need to curb demand strengthens. Sentiment indicators across Europe turned lower, with the German GfK consumer sentiment gauge for August, for example, dropping to a record low. 10-year bund yields dropped to 0.82% by Thursday, 96bp below their June high.

    • Political risk in Italy leads to wider spread relative to German bunds. The flight to safety out of Italian debt sent the 10-year Italy versus Germany yield spread to 235bp. S&P downgraded Italy’s outlook from positive to stable as the country heads towards elections on 25 September.

    • The Japanese government takes measures to address inflation. The Ministry of Finance is to deploy JPY257bn (approx. USD2bn) of budget reserves to combat rising energy prices, while the government also asked companies to keep wage increases consistent with price rises of around 2%.

      Bloomber table-29-7-22.svg

    Source: Bloomberg, July 29, 2022. Prices close of business July 28, 2022.

    Economic calendar

    01 August: G7 manufacturing PMIs, eurozone unemployment rate
    02 August: US job openings
    03 August: G7 services and composite PMIs
    04 August: UK BoE interest rate decision, US balance of trade, German factory orders,
    05 August: US non-farm payrolls, US unemployment rate

    Week to July 22, 2022
    • In a light week for US economic data, housing starts weaken to the lowest level since September 2020. Amid rising mortgage rates and rising house prices, the annualized rate of housing starts fell 2% month-on-month in June to 1.559 million units. The Philadelphia Fed Manufacturing index declined again in July, to the lowest in 10 years outside the COVID-driven low in March 2020. The 10-year US Treasury yield ended the week 3bp lower at 2.89%. For the municipal market, outflows were US$699mln though both high yield and long-term funds had some offsetting inflows of US$65mln and US$215mln, respectively. ETF inflows were just US$32mln. AAA rated tax-exempt short-term and intermediate munis were largely unchanged and lagged Treasuries. Longer-dated tax-exempt munis underperformed Treasuries by 8bp. Ten-year AAA rated tax-exempt munis are yielding 2.44% and 10-year AAA rated taxables are yielding 3.70%. Next week, the negotiated new issue calendar is very low, at US$2.9bn.

    • The European Central Bank (ECB) raises interest rates for the first time in 11 years. The ECB took center stage this week, with its well-telegraphed first interest rate increase since 2011, raising rates by 50 basis points (bp) taking the Deposit rate back up to zero. ECB President Christine Lagarde had all but confirmed a rate hike in recent months, but speculation had recently grown that the scale of the hike might be larger than the touted 25bp. Meanwhile, consumer confidence in the eurozone dropped to its lowest-ever level, falling 3.2 to -27.0 in July. Meanwhile, 10-year German Bund yields rose 6bp to 1.19%, while the euro recovered slightly against the US dollar, having recently flirted with parity, to end at $1.02.

    • Italian government bond (BTP) yields and spreads rise as political crisis unfolds. The yield on 10-year BTPs rose, and the spread of BTPs over German Bunds widened as Prime Minister Mario Draghi followed a first attempt to resign, initially rejected by the country’s president, with a second attempt as three coalition parties withdrew support, ending his 18-month tenure. The 10-year BTP yield jumped from around 3.3% to 3.6% on the news, while the BTP/Bund yield spread spiked up to 250bp. This could be a concern for Italy as approximately 35% of its debt is set to mature by the end of 2024.

    • UK inflation rises to another new high. The annual rate of inflation climbed by 9.4% in June, up from 9.1% in May, and by more than had been expected. The figure marked yet another high in the current cycle as well as being the highest for 40 years. The cost of motor fuels surged by 42.3% year on year (yoy), while food prices rose by close to 10% yoy. Annual core inflation, however, dropped marginally from 5.9% in May to 5.8% in June. Market expectations are now close to unanimous that the Bank of England (BoE) will be forced to raise rates by 0.5% in August, rather than by the recently favored 0.25%, at the next Monetary Policy Committee meeting. BoE Governor Andrew Bailey admitted in his annual Mansion House speech that a larger hike will be considered at the next meeting. Ten-year gilts were 4bp lower over the week, ending at 2.05%.

    • UK labor market remains robust but earning growth lags inflation. A further 296,000 people were in work in the UK in the three months to May, the strongest increase since August 2021, as unemployment remained unchanged at 3.8%. However, average earnings (including bonuses) rose by only 6.2% in the three months to May over the previous year, well below inflation and below expectations. Excluding bonuses average earnings grew by just 4.3% in the same period.

    • More corporate bond issues are pulled. Several corporate debt issues from EMEA-domiciled countries were postponed in June as the rising cost of issuance, slowing economic growth and a lack of investor appetite for some of these issues deterred companies from raising funds for now. Data from Bloomberg showed that postponed deals in June were three times May’s level and, according to BNP Paribas, the number of postponed issues in the past three months is likely to have exceeded the total amount for the past three years. This potentially stores up a funding problem for issuers further down the line, especially for lower-rated issuers in the high yield sector. Corporate bond performance has been poor year to date as the market faces the challenges of rising interest rates, slowing economic growth and growing risk aversion.

      Bloomber table-22-7-22.svg

    Source: Bloomberg, July 22, 2022. Prices close of business July 21, 2022.

    Economic calendar

    25 July: Germany Ifo business climate index
    26 July: US new home sales, house prices
    27 July: US Federal Reserve FOMC interest rate decision, US durable goods orders, Germany GkF Consumer confidence
    28 July: Euro area economic sentiment, consumer confidence, Germany inflation, US GDP
    29 July: Japan unemployment and consumer confidence, Euro area Inflation

    Week to July 15, 2022
    • US annual consumer inflation for June surges ahead of expectations, increasing by 9.1% (the highest since late 1981) and by 1.3% over the month, driven by energy prices that rose over 40% year on year. The headline figure rose more than the market forecast of 8.8%, while core inflation increased by 5.9%, also above expectations. Rate futures rose to reflect the possibility that the Federal Reserve may now hike rates by 1.0% at the end of the month. The yield curve between two-year and 10-year Treasuries remained inverted, a clear sign that the market is increasingly expecting a recession in the US. The inversion, at around -0.20%, is currently at its highest level for over 20 years. New issuance was moderate with Celanese issuing $7.5 billion in a long-awaited M&A financing deal; PepsiCo and PG&E also issued.

    • US municipal bond outflows exceed inflows. Outflows from weekly and monthly reporting muni mutual funds totaled $2.5 billion this week. More positively, weekly reporting funds reported inflows of $206 million with contributions from high yield and short-term funds. Faced with a heavy new issue calendar, longer dated tax-exempt municipal bonds underperformed Treasuries, but attractive pricing led to a good market reception. Finally, 10-year AAA rated tax-exempt municipal bonds are now yielding a 2.44%, while 10-year AAA rated taxable municipals are yielding a 3.85%.

    • Bank of Canada (BoC) surprises markets with a 1% rate hike. Canada’s central bank claimed the mantle of the central bank with the largest rate hike this cycle, by raising interest rates from 1.5% to 2.5%, its most significant single hike in 25 years. The BoC’s justification for the relatively large rise was that inflation had become stickier and would likely remain close to 8% for some time.

    • Eurozone Inflation rates expectations fall. Current long-term market expectations forecast annual eurozone inflation dropped below 2%, reflecting subsiding inflationary factors and a potential recession in the eurozone. Bond yields declined in the eurozone over the week and the five-year, five-year forward inflation swap rate (an indicator of medium-term inflation levels) fell below 2%, its lowest level since early March. The euro also touched parity with the dollar for the first time in 20 years. While the European Central Bank has already confirmed that it will start raising interest rates this month, end-of-year forecasts marginally declined to around 1.4%. Additionally, the EU raised its inflation forecast (from 6.1% to 7.6% in 2022 and from 2.7% to 4.0% in 2023) and cut its growth outlook (from 2.7% to 2.6% in 2022 and from 2.3% to 1.4% in 2023).

    • Issuance of European high yield debt dwindles. According to figures from Fitch Ratings, issuance of European high yield debt fell over 60% in the first half of 2021 to €24.6bn, the lowest amount for 13 years, dating back to the Global Financial Crisis. Rising interest rates, a deteriorating economic outlook and growing risk aversion have all conspired to leave would-be issuers reluctant to raise money. The report also indicated that the percentage of bonds trading 20 points below par (the distressed ratio) has risen from 0.6% to 12.8% over the first half of the year, as the spreads of high yield bonds over government bonds have widened materially.

    • The UK economy grows more than expected in May. GDP increased by 0.5% during May, well above market forecasts which had estimated no growth at all for the month. The rise followed April’s 0.2% fall with the manufacturing sector, which recorded its highest growth rate for 18 months at 1.4% month on month, contributing significantly. Both April and March’s figures were revised slightly higher.

    • Bank of England (BoE) predicts a sharp fall in inflation next year. BoE Governor Andrew Bailey stated inflation would likely fall sharply next year and could fall to the central bank’s target rate of 2% by 2024. However, he also suggested higher inflation remained likely over the short term, with the war in Ukraine continuing to push up European gas prices. The market expects inflation to reach double digits in the autumn, meaning that the BoE will almost certainly be forced to tighten policy further.

    Bloomberg table 15-7-22.svg

    Source: Bloomberg, July 15, 2022. Prices close of business July 14, 2022.

    Economic calendar

    18 July: UK house prices
    19 July: UK unemployment, US housing starts
    20 July: UK CPI, PPI and RPI, eurozone consumer confidence
    21 July: ECB monetary policy statement, UK consumer confidence, US initial jobless claims
    22 July: UK retail sales, US, eurozone and UK PMIs

    Week to July 08, 2022
    • Government bond yields fall before bouncing higher. Initially, worries about the outlook for the global economy and a raft of disappointing economic statistics saw yields decline. They subsequently recovered on the release of the Federal Open Market Committee (FOMC) minutes. Major government bond markets had rallied early in the week as traders and investors took the view that given the fragile nature of the global economy, central banks might not tighten as much as has been feared. More worrying was the third inversion of the 10-year and two-year Treasury yield spread this year. Fed futures have fallen back and the market is leaning towards the first US Federal Reserve rate cuts coming by mid-2023. Meanwhile, the US dollar continued to push higher against a basket of major currencies, while West Texas Intermediate fell below $100 for the first time in two months, before recovering.

    • The Fed to continue its tighter monetary stance. The minutes from the FOMC’s June meeting showed the Fed is very concerned about the danger that inflation could become entrenched. Therefore, it continues to feel the need to be restrictive in its policy, despite the implications for the economic outlook. The minutes also revealed a fear of losing the fight to contain inflation and this prompted last month’s 75-basis-point (bp) hike. It is contemplating at least a further 50-75bp hike at the next FOMC meeting towards the end of the month.

    • Munis see outflows. Outflows from weekly and monthly reporting municipal bond mutual funds totaled $1.7bn though high yield funds saw inflows of $118mn up to July 6, while ETFs also registered inflows of $1.7bn. Ten-year AAA rated tax-exempt munis are now yielding 2.49% and 10-year AAA rated taxable munis are yielding 3.85%.

    • European sovereign and credit spreads widen. With the economic outlook deteriorating, spreads between core and peripheral bond yields within the eurozone widened. The German 10-year/Italian 10-year yield spread rose back above 200bp over the week. High yield credit spreads also notably widened, with the iTraxx Crossover rate rising well above 600bp, its highest level since the beginning of the pandemic. Key economic data out of the eurozone was markedly weak.

    • The Bank of England (BoE) issues further warnings on UK economy. In its quarterly review of the health of the financial system, the BoE warned the outlook for the domestic economy had “deteriorated materially”. It cited the pressure on household income from rising costs, as well as slowing demand both at home and abroad. Separately, BoE chief economist Huw Pill stated in a speech during the week that the central bank was not expecting any growth for “a year or so”. Despite that, another BoE policymaker, deputy governor Jon Cunliffe, suggested the monetary authorities would do whatever it takes to keep inflation from becoming embedded, hinting at potentially steeper, interest rate hikes. However, he inferred that the economy could withstand higher interest rates.

    • Outstanding UK corporate debt levels fall. New figures revealed the amount of UK corporate debt fell by 10% to £521bn in the financial year of 2021/2022. Much of the decline in debt came in the energy sector where strong cashflows from soaring energy prices allowed companies to pay down debt. Expectations are that this trend will continue owing to companies’ reluctance to raise new debt; instead, they are looking to potentially pay down debt as interest rates rise and the economy slows.

    • The Australian central bank raises interest rates again. The Reserve Bank of Australia (RBA) increased its cash rate by a further 50bp during the week to 1.35%, its highest level for over three years. It was the third successive month that the RBA had raised rates, with the central bank warning that more hikes can be expected.

    Bloomberg table 8-7-22.svg

    Source: Bloomberg, July 08, 2022. Prices close of business July 07, 2022.

    Economic calendar

    11 July: Japan PPI
    12 July: Eurozone economic sentiment
    13 July: US CPI, German CPI, UK trade balance, UK industrial production, eurozone industrial production
    14 July: US PPI, US initial jobless claims, Japan industrial production
    15 July: China Q2 GDP, US retail sales, US consumer sentiment, US industrial production, eurozone trade balance

    Week to July 01, 2022
    • Fears about a global recession increase. Government bond yields declined over the week, as the heads of the major central banks – including the Federal Reserve (Fed)’s chairman Jerome Powell, the Bank of England’s governor Andrew Bailey and the European Central Bank’s (ECB) president Christine Lagarde – all reiterated their commitment to bringing down inflation to avoid it becoming entrenched. They were speaking at the ECB’s annual forum in Portugal.

    • US economic data continues to show strength in places, though consumer sentiment remains weak. US durable goods orders in May increased by a stronger-than-expected 0.7% month-on-month, rising for the third consecutive month, as companies continued to invest in the face of higher interest rates and rising inflation. Also, initial jobless claims for the week that ended 25 June eased to 231,000 as the labor market continued to be strong. However, the Michigan Consumer Sentiment index declined to 50.0 in June, a record low in its 70-year history, going back to 1952. Meanwhile, the Fed’s preferred measure of inflation, the core Personal Consumption Expenditures Index fell to 4.7% in May on an annual basis, its third consecutive monthly decline, but remained well above the Fed’s 2% target. The 10-year US Treasury yield fell 18bp, back below 3%, to 2.95% over the week.

    • The New York Fed launches the Corporate Bond Market Distress Index (CDMI). The New York Fed introduced an index to measure the functioning of the US corporate bond market. It is intended to help market participants recognize signs of market distress similar to those experienced during the Global Financial Crisis and in early 2020, and includes such measures as primary issuance and pricing, secondary market pricing and liquidity and comparisons between traded and non-traded bonds.

    • Redemptions continued in the muni market: Munis followed Treasury yields lower this week but to a lesser extent. Ten-year AAA rated tax-exempt munis are yielding 2.72% and 10-year AAA rated taxable munis are yielding a 3.82%. Over 29 June there was a further $1.3 billion of redemptions from mutual funds. ETFs registered inflows of $476 million though. Bid wanted activity moderated to a little over $1 billion per day. The combination of seasonal reinvestment cash and cheaper ratios continued to support the market and deals this week received a strong reception.

    • Eurozone inflation reaches a new record high. An initial estimate showed that inflation in the eurozone rose to a record high of 8.6% in June, well above the ECB’s 2% target. It was below zero (-0.3%) as recently as December 2020. However, on a core basis, inflation eased to 3.7% from 3.8%, which was a record high. The eurozone’s unemployment rate fell to a record low of 6.6% in May. The 10-year German Bund yield declined 10bp to 1.33% over the week.

    • Sentiment in Japan improves. The Bank of Japan's (BoJ) quarterly Tankan survey showed the index for large manufacturers eased from +14 in the first quarter of 2022 to +13 in the second quarter, while that for large non-manufacturers improved from +9 to +14. Annual retail sales growth was a better-than-expected 3.6% in May, the third consecutive monthly increase. The 10-year JGB yield eased 1bp to 0.22% over the week. It remained below the BoJ’s implicit 0.25% yield cap as the BoJ has continued to buy unlimited amounts of JGBs.

    • The People’s Bank of China (PBoC) continues accommodative monetary policy. PBoC governor, Yi Gang, said that the central bank would continue to have an accommodative monetary policy to support the Chinese economy as it recovers from the effects of recent COVID-19 restrictions.

    Bloomberg table 1-7-22.svg

    Source: Bloomberg, July 01, 2022. Prices close of business June 30, 2022.

    Economic calendar

    4 July: Eurozone PPI, (US holiday)
    5 July: US factory orders
    6 July: FOMC minutes; Eurozone retail sales; US ISM non-manufacturing PMI
    7 July: US ADP employment; US balance of trade; US initial jobless claims, UK house prices
    8 July: US nonfarm payrolls; US unemployment rate; Japan current account

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