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US 2Y Treasury yields briefly spiked above 5%, a level it has not breached since early March, before reversing course to close at 4.93%, down 3bp. 10Y Treasury yields rose 1bp to the highest levels since October at 4.2%. Retail sales topped forecasts of 0.4% by rising 0.7% in July, likely driven by Amazon’s Prime Day promotion. Core retail sales surged 1.0% in July, above estimates of 0.5%. The CME probability of a 25bp rate hike dropped 2% to 9.5% for the September meeting, and remained at 34% for the November meeting. China’s central bank unexpectedly cut a key interest rate by the most since 2020 to bolster an economy that’s facing fresh risks from a worsening property slump and weak consumer spending. The People’s Bank of China lowered the rate on its one-year loans by 15bp to 2.5% on Tuesday, the second reduction since June. A short-term policy rate was also cut by 10bp. US IG credit spreads were wider by 1.8bp and HY CDS spreads widened by 10.1bp. The S&P and Nasdaq were both lower by ~1.2%.
European equity markets ended lower. In credit markets, European main CDS spreads were 1.5bp wider and Crossover CDS widened 6.6bp. Asia ex-Japan CDS spreads widened 9bp. Asian equity markets have opened weaker this morning.
Tier 2 bonds are debt instruments issued by banks to meet their regulatory tier 2 capital requirements. Tier 2 capital (and thus tier 2 bonds) rank senior to tier 1 capital, which consists of common equity tier 1 (CET1) and additional tier 1 (AT1) capital. CET1 consists of a bank’s common shareholders’ equity while AT1 consists of preferred shares and hybrid securities or perpetual bonds. Tier 2 capital consists of upper tier 2 and lower tier 2 wherein the former is considered riskier to the latter. From a bond investor’s perspective, tier 2 bonds are senior, and therefore less risky compared to AT1 bonds as AT1s would be the first to absorb losses in the event of a deterioration in bank capital, as was the case with Credit Suisse.
On Betting Bonds Amidst Economic Uncertainty
Ziad Hindo, Chief Invesment Officer at Ontario Teachers
“Bond yields are much higher now than after the Covid shock making them a more appealing bet if the economy gets worse. When you’re buying bonds when yields are at circa 4%, they become more income-producing, which is attractive. The starting level of yields means that they have a better chance at diversifying the portfolio when equities sell off, when we have an economic slowdown — whereas when yields were low at zero or even negative, it was very hard to get any income or get any diversification benefit.”
On Global Bonds Outperformance
Robert Abad, product specialist at Western Asset Management
“Looking ahead six to 12 months, we think the stage is set for global bonds to outperform. The most opportune time to invest in a country’s fixed-income market is when its interest-rate cycle is stabilizing or poised to decline.”
Craig Inches, head of rates and cash at Royal London Asset Management
“UK data exacerbated concerns that inflation is becoming more embedded in the euro area too. Still, the price moves Tuesday were overdone, particularly since the UK unemployment rate is rising.”
On Pessimism Around Chinese Stocks
Wang Chen, Partner at Xufunds Investment Management
“The market has not hit the bottom yet and will probably test a new low, as there have been disappointments both on the economy and policy fronts. To reverse the downtrend in stocks, the government needs to take more measures to stabilise the job market and boost disposable incomes”
On Kenya not defaulting on its debt
Bank of America Global Research
“Kenya is unlikely to default in the upcoming 12-18 months due to access to external financing, but there are no further near-term positive catalysts. Fiscal performance is unlikely to offer any good news though; we see a muddling-through scenario in this fiscal year”