Monday Newsletter 8.31.2020

3 things to know

  • - The Federal Reserve announced the results of its policy framework review and indicated a preference to average 2% inflation over time, but stopped short of implementing a new inflation-targeting rule or preferring anything more than a “modest” overshoot of the inflation target. The other key conclusion from the framework review was an emphasis of the benefits of allowing the labor market to reach maximum employment, made official in the statement via a switch to an asymmetric unemployment objective
  • - Growth in U.S coronavirus cases was relatively steady while India set a new record for single day infections. Daily new cases in most states across the U.S. continued to fall, but the level of new cases remained very high in several states in the South and Midwest. In India, more than 78,000 new cases were reported on Sunday, as the nation eclipsed the previous highest number of cases for a single day, which stood at 77,638 set in the U.S. back in July. Global deaths exceed 844,000 and cases rose above 25 million
  • - Japanese Prime Minister Shinzo Abe announced he would step down due to worsening health issues. As the country’s longest serving leader, Abe had made it difficult for successors to raise their profile and so the party does not have a clear front-runner to replace him

What happened: The Fed revealed that it would allow inflation to exceed the central bank’s 2% target to further support the economy. The dovish shift, on top of existing stimulus measures, raised concerns about potential overshoots in the future—the U.S. dollar dropped, the 10-year Treasury yield increased, and the yield curve steepened sharply. Meanwhile, U.S. equities had a record-breaking week as the S&P 500 hit another all-time high and is on track for its best August in 34 years

  • - Equities across the developed world finished the week generally higher as the Fed announced a shift to average inflation targeting and positive news about US-China trade helped bolster risk sentiment. The S&P 500 climbed 3.3%, notching its best weekly performance since the beginning of July
  • - Rates broadly rose and curves steepened across most developed sovereigns. In the U.S., the 10 year yield rose 9bps to 0.72% and the 30 year yield rose 16 bps to 1.50%. Following a similar pattern, yield curves steepened in Germany, the U.K., Canada, and Australia on the week
  • - Credit spreads finished tighter on the week with U.S. IG spreads 1bp tighter and U.S. HY 26bps tighter. Technicals remained supportive with mutual fund flows of $8.5bn into IG credit and $1.9bn into HY for the week ended August 28th. However, supply slowed with $16bn of IG issuance and $0.04bn of HY issuance on the week. The Fed’s purchases of corporate bonds also continued to slow, dropping to approximately $24mm purchases a day and $12.6bn total
  • - Agency MBS spreads tightened on the week as limited market volatility and continued steady Fed purchases have been supportive of the asset class. The delay of the Loan Level Price Adjustment for refinancing loans did not significantly impact the mortgage market
  • - Emerging Market bonds (both hard-currency and local) were flat given the relatively quiet week, although EM currencies did post strong positive performance. This was driven mainly by the U.S. dollar’s continued depreciation, this time on the back of Fed chairman Jerome Powell’s latest update on monetary policy
  • - Municipal yields rose across the curve on the week, as short maturities increased by 2-3bps while longer dated bonds jumped by 8-10bps. Lipper reported the 15th consecutive week of muni fund inflows ($1.0bn), with year-to-date inflows increasing to $14.2bn. Market technicals are expected to weaken heading into the fall months, providing opportunities for investors to put money to work
  • - Oil prices (Brent crude) increased on the week. After bracing for supply disruptions amid storms across the Gulf Coast, prices pared gains as the impact on energy assets proved less damaging than anticipated. A larger-than-expected draw in U.S. inventories also supported markets as they continue to struggle with a weak demand backdrop
  • - Breakeven inflation rates in the U.S. strengthened over the week, moving up 14 bps to close at 1.78%, their highest level since January. Strengthening risk sentiment continued to support inflation expectations; the Fed also formally announced a widely expected shift to “average inflation targeting”— a policy that is more tolerant of temporary overshoots relative to the 2% target

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