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    Weekly fixed income review: November

    Weekly fixed income review: November

    November 25, 2022 Fixed income
    Week to November 25, 2022
    • Global bond yields slide. Global bond yields fell due to increasing concerns about the prospects for economic growth; the Fed's minutes for November indicated a potentially more dovish stance from policy committee members. The inversion between US 10-year and two-year Treasuries widened 10bp over the week to 78bp, a level not seen since 1981; an inversion between long and short rates is a historically accurate indicator of recession. New US data pointed to a slowing economy, notably the manufacturing purchasing managers' index for October, which fell below 50 to 47.6 for the first time since mid-2020, and the initial jobless claims for last week, which rose to a three-month high. In the UK, the 10-year gilt yield dropped back below 3% for the first time since early September before recovering a little, while the German 10-year Bund yield lost approximately 10bp, falling to 1.9%. The inversion between 10-year and two-year Bunds is the steepest for 30 years, with the spread below 25bp.

    • Outlook for global economic outlook revised downwards. The Organization for Economic Cooperation and Development (OECD) cut its forecast for 2023 to 2.2%, compared with an expected 3.1% in 2022. Forecasts indicate the UK economy will fare the worst among G7 nations, with its GDP slipping by 0.4% next year, owing to relatively higher inflation, labor shortages and low productivity levels. The US and the eurozone are both projected to grow by 0.5% in 2023. However, Germany is predicted to suffer a GDP contraction of 0.3%, given its high dependence on Russian gas. For 2024, the OECD forecasts a recovery, with global growth at 2.7%.

    • UK public sector net borrowing rises in October. Public borrowing jumped to £13.5bn compared with £9.2bn in the same month last year. However, the figure was materially below market estimates of around £21bn. The rise in net borrowing largely reflects the government subsidy of energy costs for households and businesses, although the market overestimated this cost in October. However, expectations are that borrowing levels will rise.

    • Expectations increase for lower eurozone interest rate hikes. A recent Reuters poll indicated a consensus among economists that the European Central Bank's (ECB) next interest hike rate will amount to 50bp. The two preceding ECB interest rate decisions resulted in rises of 75bp each, for a total of 200bp since the central bank started raising rates in July. Comments from the ECB's Chief Economist, Philip Lane, supported the economists' outlook by stating, "the platform for considering a very large hike, such as 75bp, is no longer there". Likewise, he indicated that while we can expect further tightening, the ECB will implement additional hikes in smaller increments. A majority of poll respondents expect the deposit rate to rise by a further 100bp to 2.5% over the next two policy meetings, which will take place in December and the first quarter of 2023.

    • Net inflows into investment grade euro-denominated corporate debt rise. According to data from Refinitiv Lipper, investors purchased the highest amount this year in the week to 9 November, totaling $1.17bn of euro investment grade bonds. Investors have ploughed more money into the sector over the past month, attracted by relatively high bond yields and the relative safety of investment grade issues, amid growing expectations that the pace of interest rate hikes is slowing. As a result, the iBoxx Euro Corporate Bond Index began to recover in November, after hitting its lowest level in over ten years in late October.

    • New Zealand hikes rates by a record amount. The Reserve Bank of New Zealand increased its Official Cash Rate by 75bp to 4.25%, the largest hike in its history. It marked the country's ninth consecutive increase in interest rates and took its official cash rate to its highest level for nearly 14 years. With annual inflation close to a 32-year high, the central bank warned that interest rates would need to head higher.

    Bloomber table 25-11-22

    Source: Bloomberg, November 25, 2022. Prices close of business November 24, 2022.

    Economic calendar

    28 Nov: Japan large retailer sales, Japan unemployment.
    29 Nov: US consumer confidence, eurozone economic sentiment, UK consumer credit.
    30 Nov: UK (BRC) shop price index, UK house prices, US (ADP) private employment, US trade balance.
    01 Dec: Eurozone unemployment, US initial jobless claims, China (Caixin) manufacturing PMI, Germany retail sales.
    02 Dec: US non-farm payrolls, US unemployment, eurozone PPI, Germany trade balance.

    Week to November 18, 2022
    • US PPI improves. Following last week’s better-than-expected consumer inflation data for October, the pace of the PPI (producer price inflation) also slowed, rising by 8% year-on-year and by 0.2% over the month – in each case, this was less than markets anticipated. Subsequently Federal Reserve Vice Chair Lael Brainard reportedly suggested that “it will probably be appropriate soon to move to a slower pace of increases”, and that she favoured a 50bp rather than 75bp hike at the next policy meeting. However, more hawkish soundings emanated from other Fed officials, some of whom suggested that the tightening cycle could last longer than currently expected by the market. Meanwhile, the inversion between the 2-year and 10-year Treasury yield hit 70bp during the week, its widest for 40 years, indicating that a US recession is very likely in the medium term. Credit spreads were 6bp tighter in the past week driven by strong technicals and a continued rally after better-than-expected CPI data.  For the second week in a row, investment grade issuance has been over $20bn as companies took advantage of higher risk appetite from investors.

    • Muni yields fall. On Thursday, AAA tax-exempt muni yields fell 3-5bp and the asset class outperformed Treasuries which had weakened on comments Fed officials on Thursday. Over the past week, tax-exempt high grade muni bonds also outperformed Treasuries with yields falling between 20-30bp. The long muni-to-Treasury yield ratio fell from 95% to a relatively rich 92%. The improved muni market tone comes on the heels of a two-week Treasury rally and was aided by consistently strong investor demand, light dealer inventories and a very manageable new issue supply calendar. For the seven-day period ending 16 November, Lipper reported combined monthly and weekly fund inflows totalling $605m, with ETFs reporting $1.8bn of inflows. New issues that came to market this week were well received with notable oversubscriptions of up to 20 times for maturities in the PA Turnpike and Nashville Airport deals. 

    • European corporate borrowers see a large jump in the cost of debt. According to Bloomberg, the interest payments for new debt from investment grade borrowers in Europe rose 3bp last week, the largest weekly rise for over 10 years. While higher credit-risk companies have seen steeper rises in required coupon rates, the usually stable coupon rates for top-quality corporates have also moved higher, creating a potential headwind for these firms’ earnings outlooks.

    • Asian central banks hike rates. Both the Bank of Indonesia and the Bank of the Philippines raised interest rates, by 50bp and 75bp respectively, continuing the trend of tightening from Asian central banks over the past year. China and Japan continue to be the main exceptions, with both countries pursuing easy monetary policy as economic growth, not inflation, remains the key issue. Still-tight COVID-related restrictions in China continue to limit economic growth. Annual consumer inflation in Japan rose to 3.7% in October, the highest rate for 31 years. Surging imported energy costs, exacerbated by the weak yen, was a key driver of the rise. Core inflation, which excludes fresh food prices, increased by 3.6%, the largest rise for 40 years. Nevertheless, the Bank of Japan reaffirmed its commitment to loose monetary policy, explaining that it expected inflation to fall back to 2% in the next financial year.

    • UK inflation climbs above 11%. Annual consumer inflation rose to 11.1% in October, a significant jump from September’s 10.1% and ahead of market forecasts. Energy costs rose substantially (gas prices increased by nearly 130%), while food prices increased by 16.5% year-on-year, the largest increase for 45 years. Some cheer was provided by the fact that core inflation (excluding energy and food costs) was unchanged at 6.5%. Wages, excluding bonuses, rose ahead of expectations, growing by 5.7% year-on-year in the three months to September. However, with September’s reading of 10.1%, this entailed a fall in wages in real terms of 3.7%. The market expects wage pressure to continue to grow given the much steeper cost of living.

    Bloomber table 18-11-22

    Source: Bloomberg, November 18, 2022. Prices close of business November 17, 2022.

    Economic calendar

    21 Nov: Germany PPI
    22 Nov: Eurozone consumer confidence, UK public sector net borrowing
    23 Nov: US, UK, eurozone (flash Nov) PMIs, US durable goods orders, US initial jobless claims
    24 Nov: Japan (flash Nov) PMI, Japan leading economic index, Germany IFO business climate
    25 Nov: UK GfK consumer confidence

    Week to November 11, 2022
    • Lower-than-expected US inflation print causes markets to surge. The annual consumer inflation figure for October came in at 7.7%, compared with consensus forecasts of approximately 8%. It was the lowest reading since January and marked the fourth consecutive fall in inflation since June's peak of 9.1%. Core inflation also dropped from 6.6% to 6.3% over the month. The release of the figures caused a surge in equity and bond prices and a fall in the US dollar. The S&P 500 Index rose by 5.5%, its biggest daily jump in over two years. The 10-year Treasury yield fell by almost 30bp on the data, moving towards 3.8%. The two-year Treasury bond yield, which had traded up to over 4.7% early in the week (its highest level for 15 years), fell to 4.3%. The inflation figure encouraged hopes that the US Federal Reserve would begin to reduce the size of its future interest rate hikes, and the market forecast for peak rates next year dropped below 4.9%.

    • Calls for more rate hikes in the eurozone. The head of the Bank of France and European Central Bank policymaker Francois Villeroy de Galhau stated that interest rates must continue to rise until inflation in the eurozone has peaked. He said, "as long as underlying inflation has not clearly peaked, we shouldn't stop on rates". Eurozone inflation jumped to nearly 11% last month, and the market expects the bank deposit rate in the euro area to double from the current 1.5% to 3% sometime next year. Villeroy de Galhau believes inflation won't peak until the first quarter of 2023. However, he suggested the central bank could moderate its rate hikes thereafter, especially if rate increases prove restrictive for economic growth.

    • Inflation in China moderates. Both the consumer price and producer price indices weakened in October. Consumer price inflation fell to a five-month low of 2.1%, while producer price inflation fell 1.3% year on year, the first fall for almost two years. Slowing economic activity due to tight Covid restrictions, waning overseas demand, and falling imported commodity prices were the key factors behind the slowdown in inflationary pressure in the country. Additionally, data showed that new loan growth had dropped dramatically in October. New yuan loans made by banks in China slid by 75% over the month, falling to 620bn yuan from 2.47tn yuan in September, reaching the lowest level for almost five years and reflecting an increasingly fragile domestic economy exacerbated by COVID restrictions.

    • Further rate hikes in the UK deemed necessary. In a speech during the week, Bank of England (BoE) Chief Economist Huw Pill suggested that, despite recent interest rate hikes, more rises are required to prevent inflation from becoming entrenched in the system. Expectations of peak rates in the UK, anticipated in 2023, have settled at around 4.5-4.75%, below the recent extreme of over 6% following Liz Truss’s infamous mini-budget. Pill also highlighted the current tightness in the labor market, partly spurred by large numbers of people retiring from the workforce, as a critical factor in pushing inflation higher, with the situation unlikely to change for the better for the foreseeable future. He also warned the government on planned tax hikes, saying raising taxes could “slow down spending in the economy more than we expect”. With a £50-£60bn hole in the UK’s finances, UK Chancellor Jeremy Hunt is expected to announce plans for steep public spending cuts and sizeable tax (and stealth tax) rises in his Autumn Statement next week.

    • UK third-quarter GDP falls, but by less than expected. GDP fell 0.2% quarter on quarter in the third quarter, a better result than markets had expected. It was the first drop in six quarters, dating back to the first quarter of 2021. While consumer spending and private business investment fell 0.5%, exports rose by 8%, partly encouraged by a weaker pound. The Bank of England had recently predicted that GDP would dip by 0.75% in the second half of 2022 and remain negative through 2023.

    Bloomber table 11-11-22

    Source: Bloomberg, November 11, 2022. Prices close of business November 10, 2022.

    Economic calendar

    14 Nov: Eurozone industrial production, Japan Q3 GDP.
    15 Nov: UK unemployment, UK average wages, US PPI, eurozone trade balance.
    16 Nov: UK CPI, PPI and RPI, US retail sales, US industrial production.
    17 Nov: Eurozone (harmonized) CPI, Japan CPI, US initial jobless claims.
    18 Nov: UK retail sales, US home sales.

    Week to November 04, 2022
    • The US Federal Reserve raises rates by another 75bp. The Fed increased the Fed Funds rate to 3.75%-4.00%, the highest level since 2008, in its sixth successive rate hike and the fourth consecutive increase of 75bp. As the move had largely been expected by the market, much attention was focused on the accompanying statement from Fed Chairman Jerome Powell, who raised the possibility that the pace of interest rate hikes could ease as the Fed analyses their lagged impact on the economy. But he warned that rates would likely need to rise further and added they might peak at a higher level than currently expected. Bond yields rose and equities fell after investors digested Powell’s message. Short rates moved by more than rates at longer maturities, leading to a further inversion of the yield curve. The two-year/10-year yield spread expanded to 55bp, the widest seen this cycle and for many decades.

    • Munis recover to outperform Treasuries. Munis outperformed Treasuries this week. Tax-exempt AAA rated muni yields fell 1bp-2bp at the front end and declined 8bp on the long end, in contrast to Treasury yields which rose across the curve. The long muni to Treasury yield ratio fell to 98% from 102%. Market tone improved on a light new issue calendar with the strongest investor demand inside 12 years. The few new issues that came to market did well. For the seven-day period ending November 2nd, monthly and weekly reporting open end mutual funds reported outflows totaling $3.1 billion, however, ETFs received a massive $4 billion of flows. Next week, new issue supply is estimated at $5.5 billion with $1.9 billion in taxable issuance. Ten-year AAA rated tax-exempt munis are now yielding 3.36% and 10-year AAA rated taxable munis are yielding approximately 5.20%-5.25%.

    • The Bank of England (BoE) mirrors the Fed with 75bp rate hike and starts reducing its bond holdings. As expected, the BoE raised rates by 75bp, bringing base rates to 3%, their highest level since 2008. It was the largest hike since 1989, beyond the short-lived 200bp hike on Black Wednesday, 16 September 1992. The BoE also began to sell off the government bond holdings accumulated during the many years of quantitative easing. It successfully sold £750m of bonds at auction during the week and has a target of reducing its balance sheet by £80bn through bond sales over the next year. It is the first major central bank to reduce its bond holdings through the open market.

    • Eurozone inflation marks a new all-time high. The annual inflation rate in the eurozone for October broke double digits as it rose to 10.7%. This is the highest level since records began and represented a substantial rise from September’s 9.9%. Energy prices rose by more than 40%, while food prices continued to pick up strongly, rising by over 13%. The European Central Bank raised rates by 75bp last week, amid hopes that the hiking cycle might soften going forward, but October’s data shows that inflation is still very much on an upward trajectory, at a time when economic growth is waning. GDP data for the third quarter showed growth of just 0.2% over the period, the weakest quarterly figure for six quarters.

    • UK corporate bond issues plummet in third quarter. According to data from Refinitiv, the value of corporate bonds issued by UK companies fell by over 50% in the third quarter as borrowing costs rose substantially. While this fall in issuance has been a global feature, it has been more pronounced in the UK. Euro-denominated bond issuance declined in the third quarter, falling by 20%. Recent issues by some well-rated UK utility companies have come with elevated yields. For example, one utility company issue had a yield in excess of 6.5%. Even though the gilt market and sterling have stabilized following a reversal of the September ‘mini budget’ which has provided greater comfort around the country’s finances, many UK companies – especially in the high yield sector – are seeing bond yields, even on short-dated maturities as high as 15%-16%.

    • The Bank of Japan (BoJ) remains committed to maintaining loose monetary policy. In a speech early in the week, BoJ Governor Haruhiko Kuroda stated that it was imperative that the central bank maintain loose monetary policy, given the sluggish nature of the economy. This stance has seen bond yields remain very low by international standards, and the yen weaken substantially against the US dollar, falling to 32-year lows. There had been recent speculation that the BoJ could begin to tolerate gradually tighter monetary policy, with both headline and core inflation having hit 3%. While playing down the immediate prospect of this, Kuroda did keep the door ajar for a potential change in policy; he suggested that raising its yield targets and allowing bond yields to increase might become an option if inflation continues to rise, provided it is accompanied by wage growth.

    Bloomber table 04-11-22

    Source: Bloomberg, November 04, 2022. Prices close of business November 03, 2022.

    Economic calendar

    07 Nov: China balance of trade, UK house prices.
    08 Nov: Japan household spending, Eurozone retail sales.
    09 Nov: China inflation.
    10 Nov: US inflation.
    11 Nov: Germany inflation, UK GDP, US Michigan consumer sentiment.

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