Weekly fixed income review | Insight Investment

• The US Federal Reserve (Fed) is to accelerate the speed of it tapering process. The Fed will double the tapering of its $120bn monthly asset purchases from $15bn in November to $30bn in January given growing concern about rising inflation, meaning that it is now set to remove its quantitative easing stimulus by the end of March. The Fed also officially dropped its use of the word “transitory” to describe inflation. An updated “dot plot” of policymakers’ individual interest rate projections showed that they now expect three rate hikes in each of 2022 and 2023 plus a further two in 2024 as the economy approaches full employment. US producer prices rose more than expected to 9.6% yoy in November, a level seen only once in the past 40 years. Congress finally voted to raise the US debt ceiling by $2.5trn just before the 15 December deadline, narrowly avoiding a debt default and ensuring the US government would be funded through the midterm elections next November into early 2023. The 10-year US Treasury yield fell during the week to 1.41%.
  
  
• High grade municipals outperformed Treasuries.  Fed chair Powell’s patient messaging for the future path of rate hikes supported municipals relative to Treasuries. Secondary and institutional trading was elevated through Wednesday’s trading session. Demand for longer-date municipals was particularly notable with elevated volume in 10yr-30yr maturities. Municipal weekly inflows (as measured by Lipper) advanced, with $603 million into funds during the week ended November 3rd. Robust year-to-date flows have hit $92.1 billion and still register the second highest on record after 76 of successive 77 weeks.
  
  
• The Bank of England increased its base rate to 0.25%, on rising inflation concerns. The Bank of England (BoE) surprised many market participants by increasing the official interest rate to 0.25% from 0.1% at Thursday’s Monetary Policy Committee meeting, the first rate increase in three years. Many expected the uncertainty caused by rising COVID-19 cases to forestall the first rate move until the new year. The central bank’s decision came after annual inflation increased from 4.2% in October to a greater-than-expected 5.1% in November, the highest rate since September 2011 and well above the BoE’s target of 2%. The IMF warned that the BoE should not delay in raising rates, predicting inflation would peak at 5.5% next spring. Meanwhile 10-year gilt yields rose slightly to 0.76%
  
  
• The European Central Bank (ECB) left monetary policy unchanged. Despite inflation remaining above its 2% target, the ECB kept rates unchanged. ECB president, Christine Lagarde, confirmed that net purchases under the €1.85 trillion Pandemic Emergency Purchase Program would stop in March, as previously signalled. Monthly purchases under the older Asset Purchase Program will increase from €20bn to €40bn initially though, before being reduce again in 2022. Ten-year German bund yields remained at -0.35%.
  
  
• In emerging markets, the Central Bank of Turkey cut interest rates again.  President Erdogan continued pursuing unorthodox monetary policy in Turkey, despite inflation recently rising above 21% (compared with the mid-point target of 5%). The Turkish lira further depreciated, moving through 15 against the US dollar.

Chart of the Week: Short term interest rates (adjusted for inflation) are at 20-year lows

Source: Bloomberg. Data as at December 17, 2021.

Source: Bloomberg, 17 December 2021. Prices close of business 16 December 2021.

Economic calendar

20 December: People’s Bank of China interest rate decision
21 December: US current account
22 December: UK GDP, US GDP
23 December: US core PCE, US jobless claims, US durable goods orders, US personal income & spending
24 December: Japan CPI

• US government bonds gave back some of their recent gains. Yields in US Treasuries rose gently over the week, reflecting a shift in sentiment that the worst fears about the Omicron variant were largely unfounded. Additionally, news came through mid-week that testing had shown a third dose of Pfizer and BioNTech’s vaccines was effective in limiting the effects of Omicron. The market’s attention began to shift towards the release of November’s US consumer price index on Friday. The two-year/10-year yield curve remained close to its flattest level since the pandemic began as two-year Treasury yields rose more than 10-year Treasury yields over the week. Corporate spreads were 3bp wider at 96bp. New issuance was moderate including Dell, Western Digital and GLP.
  
  
• The International Monetary Fund (IMF) has backed loose monetary policy in the eurozone. A report from the IMF suggested the European Central Bank should continue to support the fight against COVID-19 with loose monetary policy, and that this should continue to be a priority as currently high inflation rates were unlikely to persist, in its view. Eurozone bond yields climbed during the week, in line with other global bond markets, as the worst fears about Omicron waned.
  
  
• China cut large banks’ reserve requirements while concerns about Evergrande grew. The People’s Bank of China reduced the reserve requirement ratio for the country’s larger banks by 50bp to 11.5%, in an effort to boost liquidity in the system. The authorities continue to be worried by the property market, especially as fears grew that property developer Evergrande had missed settling an approximate $80m interest payment on an overseas bond within a 30-day grace period which ended on 6 December. Additionally, there are fears that another property company, Kaisa Group, is close to default. Fitch, the ratings agency, revised its ratings of Evergrande and Kaisa down from ‘C’ to ‘RD’ (restricted default).
  
  
• Emerging market rate rises. In contrast to major developed central banks which continue to agonise over when, and if, to implement rate hikes, the Central Bank of Brazil raised its benchmark rate by 150bp to 9.25% for the seventh hike this year, while the National Bank of Poland raised rates by 50bp to 1.75%, the third hike in as many months.

Chart of the Week: 2 and 10-year Treasury curves converge

Source: Bloomberg. Data as at December 10, 2021.

Source: Bloomberg, 10 December 2021. Prices close of business 09 December 2021.

Economic calendar

13 December: UK financial stability report
14 December: US PPI, UK unemployment, eurozone industrial production
15 December: UK CPI, RPI and PPI, US retail sales, China industrial production
16 December: US housing starts, US initial jobless claims, eurozone composite PMI
17 December: UK retail sales, UK consumer confidence, eurozone CPI

• Global bond markets rallied as concerns rose over the spread of the Omicron variant. Investors sought the perceived safe havens of mainstream government bonds as several cases of Omicron were identified around the world. Markets reflected concerns that the new variant may be more infectious than other COVID-19 strains, while the CEO of Moderna, a biotechnology company, warned existing vaccines may not be as effective against Omicron. While bond markets were largely stronger, prices of many commodities, including oil, fell back as November ended.
  
  
• US Federal Reserve (Fed) Chairman Jerome Powell dropped the word “transitory” from his description of inflation. At a Senate Banking Committee hearing during the week, Powell said high inflation levels may remain for longer than expected due to ongoing pandemic-driven labor and product shortages. He said “factors pushing inflation upward will linger well into next year”, while conceding that “price increases have spread much more broadly”. Importantly, the word ‘transitory’ disappeared from his prepared text. Powell went on to state that the Fed would be ready to taper its current rate of monthly bond purchases more quickly than previously flagged, if inflation continued to rise. The 10-year Treasury yield has continued to decline below 1.5%, while two-year Treasury yields now exceed 0.6%, leading to the 2-year/10-year curve ending at its flattest since January.
  
  
• Expectations for a December rate increase in the UK have softened. The market’s conviction that the Bank of England (BoE) would likely raise interest rates in December has waned with the emergence of Omicron. The BoE’s chief economist Huw Pill stated that the new strain of COVID-19 “clearly would change our view of the world”. Another BoE policymaker, Catherine Mann, appeared to echo Jerome Powell, suggesting the variant could negatively impact growth but still stoke inflationary pressures.
  
  
• Eurozone inflation rose to a 30-year high. The consumer price index in the euro area increased by 4.9% year on year in November, greater than market forecasts, and up from October’s 4.1%. Energy costs continued to drive inflation higher, rising by over 27%. The eurozone’s producer price index also rose well ahead of expectations, climbing by 5.4% over the month and 21.9% year on year in November. The surge in inflation has put further pressure on the monetary authorities to begin to tighten policy. The European Central Bank has consistently maintained the risk to economic recovery from COVID-19 meant that monetary policy should continue to be as supportive as possible. However, there were more calls for the central bank to begin to wind down its pandemic emergency purchase scheme. The 10-year German bund yield fell to its lowest level for three months.

Chart of the Week: Oil prices softened with West Texas Intermediate futures falling below $70/bbl

Source: Bloomberg. Data as at December 3, 2021.

Source: Bloomberg, December 3, 2021. Prices close of business December 2, 2021.

Economic calendar