• October 9th, 2023
• By Midsilver Investment Limited

As the hiking phase neared its conclusion, investors during the quarter honed in on macroeconomic trends, simultaneously remaining alert to their policy consequences. Advanced economies (AEs) witnessed an uptick in government bond yields, with their term structures capturing varying economic predictions. Even with a brief period of reduced risk in August, there was a general trend towards risk-taking, including in emerging market economies (EMEs).

There were distinct patterns in government bond yields when comparing China, the euro area, and the US. US long-term yields climbed to peaks not observed since prior to the Major Financial Crisis. In contrast, yields in the euro area saw only a minor increase. These differing trajectories can be attributed to inflation-adjusted or "real" yields, suggesting a brighter economic future for the US as compared to the euro area. Persistent inflation in the euro area caused short-term rates to ascend, leading to a further inversion in the term structure. In China, bond yields predominantly dropped due to a lagging recovery from Covid-related measures and a more lenient monetary policy.

US Treasury bonds became the epicenter of market turbulence in early August. A rapid surge in yields occurred as investors grew confident about the permanence of higher rates, especially in light of the US's better-than-anticipated growth data. This was coupled with several nearly simultaneous developments that created investor apprehension and triggered a market sell-off: an unforeseen rise in long-term bond issuance by the US, a change in the Bank of Japan's approach to yield curve control, and a downgrading of the US's credit rating. This surge in US yields had repercussions in other AE bond markets.

Although risky assets remained robust, there were variations among major economies due to diverse economic prospects. Mirroring bond market behaviors, US stock returns outperformed those in the euro area and China. Similarly, corporate credit market sentiment seemed more upbeat in the US than in the euro area. US credit spreads shrank to levels below historical averages, and there was a noticeable uptick in issuance. Contrarily, bank credits to businesses remained tepid universally.

In EMEs, financial market activities were shaped by a shifting phase of monetary policies and external elements. As the monetary posture started changing, short yields decreased, with many central banks either holding off on rate increases or opting for reductions. Risk appetite persisted, pulling in capital towards higher-yield currencies. In August, EME spreads and exchange rates responded to the transient de-risking phase in AE markets: the upward trend of Latin American currencies paused, speculative stances in currency futures dwindled, and the ascent of long-term yields quickened. There were also challenges stemming from China's decelerating economy.