Markets were hit by the highest levels of volatility recorded in nearly a decade last month, fuelled by better than expected inflation data and a subsequent spike in global bond yields in January.
After the spike in bond yields in January, February’s price action was a bit more measured. Total returns in the core government bond markets were basically flat for the month. Returns are still negative for the year to date, however.
In the UK, the Bank of England appeared to adopt a more hawkish tone, though the Monetary Policy Committee unanimously elected to keep interest rates unchanged. Governor Mark Carney said the Bank recognised the need to gradually raise interest rates, but cautioned it may have to take place both earlier and to a greater extent than what was considered in November.
A stronger than expected global economy, improving wages, and a weak outlook for the UK’s potential supply underpinned the Bank’s more hawkish position. Markets appear fairly relaxed about the outlook for interest rates however as the sterling cash market is pricing in just one 25 basis points (bps) rate hike in the UK in the second half of 2018.
The yield on 10-year gilts ended the month around 1bps lower at 1.50 per cent, while total returns for the gilt index were at +0.25 per cent. With the underlying gilt curve remaining basically unchanged for the month, high grade corporate spreads ended the month 11bps wider, with total returns standing at -0.87 per cent. High grade corporate spreads ended the month 11bps wider, with total returns standing at -0.87 per cent.
The US’ Federal Open Market Committee did not meet in February but also elected to leave rates unchanged at the meeting on 31 January. The cash market is still pricing in between two and three potential rate hikes by the end of the year, which is more or less in line with the Federal Reserve’s target of five rate hikes by the end of 2019.
The yield on the 10-year Treasury closed at 2.951 per cent, a multi-year high, on 21 February on the back of a string of more positive macro data. However, this move higher had been retraced by the end of the month, as the possibility of a global trade war began to raise its head and a ‘flight-to-quality’ bid took hold. The yield was 15bps higher at 2.86 per cent by the end of February.
Excess and total returns were all negative for the month, in response to the move in the underlying Treasury curve and widening spread. US high grade credit spreads were 9 bps wider in February, at +101bps, while high yield spreads were 17bps wider for the month. Total returns for the high yield sector stood at -0.56 per cent for the month, but are at +1.08 per cent for the year to date.
The European Central Bank also did not meet in February but there were no changes to monetary policy following the meeting in January and the accompanying statement remained basically unchanged. The Bank remains concerned about volatility in the foreign exchange markets as this represents a downside risk to the macroeconomic outlook. Inflation remains below target but the Governing Council has strengthened its view that it will gradually converge towards 2 per cent. Markets anticipate the discussion will soon turn to a gradual tapering of the asset purchase programme.
The yield on the 10-year bund ended the month 5bps lower at 0.65 per cent, with the bund index producing total returns of +0.17 per cent. Total returns for the other core and peripheral government bond indices were mixed, as Greek debt underperformed following a bout of profit-taking on the back of the country’s successful bailout agreement.
High grade spreads were 5bps wider in February, standing at +81 bps .Excess and total returns were negative in the main for February as a consequence of spread widening and high grade total returns now stand at -0.27 per cent for the year.
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