Geopolitical event risk has risen but appears to be relatively contained from a market perspective.
Central Banks currently remain on hold but recent data hasn't necessarily gone their way. The real story for financial markets leading into Q4 was the continued destruction of the long end which has led to flattening of yield curves through bear steepening. The long bond has suffered the worst volatility since the pandemic hit in 2020.
The reality of funding the US deficit has hit home hard. $6 trillion is a big number and that is what the Fed has to raise in T-Bills. However simply funding through T-bills is not possible so the long end has also had to bear the brunt of a trillion dollars of new issuance. Whilst this has been taken down well overall, the last 30 year auction was weak, with a cover of 2.35x and a tail of 10bp. The net effect has been to push 30 year yields higher by 55bp, a capital hit of 8.7% and narrowing 2's 30's from -67bp to -20bp. US 30 year fixed mortgage rates have risen to 7.92%, a major part of the US housing market, and activity has fallen off a cliff as supply is stifled by existing mortgage holders having no wish to move and refinance at these levels.
The ECB also has to watch and help eurozone member states maintain a collective debt to GDP ratio of more than 91% over the funding period. Bear in mind that in all this Central Banks are attempting to shrink their balance sheets removing them as the marginal buyer of new issuance. One can take a crumb of comfort that due to their biggest influence being at the short end of the curve, longer dated rates rising does help do their job for them.
The UK saw the Bank on hold amongst a better than expected print of GDP at 0.2% and CPI holding at 6.7%. The DMO has to raise £238bn from Gilt sales over the year, a fair proportion from our long end too and this along with the collapse of LDI activity one year on from last year’s debacle has turned the long end into an illiquid ghost town. As mentioned before we have spent most of the year on the heels of others recommending buying duration, the 30 year Gilt is down over 20% ytd so this has not been the right tactic. There will come a time but with much better yields still available at the short end this is currently not attractive.
Credit spreads widened from 70bp to 84bp for the iTraxx and from 161bp to 168bp for Sterling spreads. Issuance remained healthy and again quality A rated names are continuing to access the market.
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