Markets remain in thrall of Central Bank action and bond market volatility has spiked.
Higher for longer hints are being dropped, some not so subtly, and as the cost of borrowing returns to long term normality, many are still getting used to interest rates that they have not experienced before. However, as the transmission system is seemingly more extended and inefficient, the delay factor does run the risk of over-tightening, something that Central Bankers seem willing to accept. Longer duration assets have, again, seen their fair share of volatility.
The Federal Reserve are rightly taking a brief pause in their hiking cycle to attempt to measure the effects of their 10 straight hikes. Stresses and strains were to be expected and Chairman Powell has warned of them many times. We saw the regional banking problems in Q1 but strains are also visible in the commercial real estate and CLO markets where values have plummeted and spreads have ballooned.
The ECB remains on course to pile on the pain, remember that it is still less than a year ago that they were pursuing a negative rate policy (crazy). Germany’s technical recession is evidence of that pain, but their recent manufacturing numbers were stronger and cause for optimism that it may be short and shallow. June EU core inflation numbers were not encouraging though as they showed a re-acceleration to 5.4% as the cost of services increased.
The Bank of England and its Governor fight for their credibility in a way that we have not experienced before. Whilst no one envies them their role, the delay in withdrawing liquidity and starting to normalise rates was down to their procrastination and no one else’s. The effects of their last 50bp hike are still reverberating around mortgage markets and yet we still have not seen a moderation in core inflation rates.
The pattern of issuance (in Sterling) continues to be skewed to the short to medium end of the curve and with 2 year Gilts now yielding well north of 5% there are some remarkable coupons printing from high grade borrowers. As issuers cast around for different rate and risk profiles, we have the spectre of Credit Agricole issuing an inaugural Panda bond denominated in Yuan into Chinese markets. The proceeds are to be remitted offshore for use in their ongoing operations, but it feels like this has a whole new arena of risk attached to it.
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