Bond rally fizzles out

The four-week string of gains came to a halt for bonds.

The 10-year Treasury yield rebounded from 3.504% to 3.586%. Similarly, the 2-year yield gained 6 basis points from 4.280% to 4.342%. With a deeply inverted yield curve (+75 basis points, a four-decade extreme), the likelihood of the US economy slipping into recession is high. The Fed Fund futures closed at 95.045 (May 2023), hence a terminal rate which is still priced above 4.95% for next spring.

In Europe, the yield on the German 10-year Bund rose from 1.86% to 1.93%. The French 10-year OAT yield moved in tandem with the German Bund, adding 9 basis points from 2.30% to 2.39% while the UK 10-year Gilt gained 3 basis points from 3.15% to 3.18%. 

With the eurozone CPI still at double figures, the European Central Bank will have to continue raising interest rates for some time. In addition, it’s worth noting that it has already started to shrink its balance sheet as the Eurozone banks repaid €296bn of loans last month. It was the biggest cash withdrawal from the Eurozone financial system in history and a first step towards mopping up more liquidity in 2023 from the ECB balance sheet to fight inflation.

As a result, the EUR-USD pair kept up its momentum (+0.65%) for the fifth week in a row. After a 2-month rally, the GBP-USD pair turned into sideway trading just below 1.23 as the Bank of England is set to announce its monetary policy decision next week, with another interest rate hike of 50 basis points expected. The dollar index, which tracks the greenback against a basket of six other currencies, has fallen more than 9% this quarter. 

All the bond segments slid slightly this week in the wake of rising yields. Investment grade corporate bond prices edged down 0.08% in Europe (IBOXX € Liquid Corporates index down 11.30% YTD) and 0.03% in the U.S. (IBOXX Ishares $ Investment Grade Corporate Bond Index down 15.42% YTD).

High-yield bonds lost 0.32% in Europe (IBOXX € Liquid High Yield Index down 8.82% YTD) and 0.09% in the U.S. (Markit iBoxx USD Liquid High Yield Capped Index down 7.41% YTD).

Emerging debt in local currencies was down 0.39% over the week (down 15.44% year-to-date).