There have been several downside surprises to China’s reopening.

3. The People’s Bank of China (PBOC) is attempting to inject liquidity into its financial system with a cut to its 7-day reverse repo facility³ from 2.0% to 1.9%. Thus far, there have been several downside surprises to China’s reopening, such as low prints in manufacturing PMI for several months. We're looking closely at the Chinese policymaking community’s expected reaction function⁴ to the weaker data. The recent appointment of Pan Gongsheng, a highly respected technocratic deputy governor, as party chief of the PBOC signals how serious Beijing considers the current situation.

4. The Supreme Court stymied the Biden administration’s plans for large-scale debt forgiveness in elements of the federal student-loan programs. About $430 billion of student loans would have been forgiven under the proposal. The executive branch vowed to find another way. However, such actions will likely take some time, including a lengthy comment period under the current administrative process. Why is this important for fixed-income markets? The 18-29 age group has the largest student debt burden (FIGURE 3). Debt forgiveness would have been a substantial delevering event for this group and may have been a powerful longer-term tailwind for consumer spending. As a reminder, under the terms of the current debt-ceiling deal, the student-loan payment moratorium ends at the end of the summer.

5. Commercial real estate (CRE) market fundamentals remain challenged. Commercial mortgage-backed security (CMBS) loan delinquencies increased to 3.5% in May, according to JP Morgan, and a large borrower during June stopped payment on a CMBS loan backed by two San Francisco hotels. However, in a positive development, a New York office building at 245 Park Avenue sold during the month at a valuation just 10% below its 2017 appraisal. The transaction suggests that there's some investor appetite for New York office space and reinforces our view that not all CRE is bad, just that performance will vary greatly by region/sub-market. Office and retail malls appear most at risk while the industrial and multifamily property segments should benefit from more stable net operating income and are starting from a position of relative strength.

6. Hawkish rhetoric rained at the European Central Bank (ECB) Forum on Central Banking in Sintra, Portugal. ECB President Lagarde signaled the council would have to do more than the market is pricing if companies don’t absorb the rise in wages into profit margins. And US Federal Reserve (Fed) Chair Powell remarked that rates have only started to become restrictive, laying the groundwork for the hiking cycle to continue. Meanwhile, Japan’s Governor Ueda suggested that if BOJ forecasts are right for 2024, it should be exiting its accommodative policies.

Canadian inflation data continues to run hot, powered by an unfazed Canadian consumer.

What’s Keeping Us Up at Night…

1. There was an attempted coup in Russia over the course of one weekend in June. A faction of the Russian military, the Wagner Group, seized the headquarters of the Southern Military District and then proceeded to drive on to Moscow. They did so with little or no effective opposition from the Russian military. Indeed, some commentators speculate that mutineers had either help or sympathy from elements of the Russian military. One cannot fully overestimate how dangerous this event was for broader geopolitical stability. Outright conflicts between factions of the armed forces in nuclear armed states are exceedingly alarming and highlight how much geopolitical risk can now start dominating markets. While the mutiny/coup ended, we believe there would have been a sharp market reaction if the events had not resolved themselves over the course of a few days. Prolonged conflict would have likely led to a risk sell-off and flight-to-quality trade.

2. The Bank of Canada (BOC) may continue to hike rates as Canadian inflation data still runs hot, powered by an unfazed Canadian consumer. The BOC was one of the first major central banks to signal a pause, amid confidence that the economy would slow below trend and labor-market spare capacity would ease, leading to lower service-based inflation. The resilience so far in the labor market, stickiness of wage growth, and strong underlying inflation pulse prompted a hike at the June policy meeting. Much like the Fed, it will be hard for the BOC to take comfort in a sustainable move lower and back toward target without a more material slowing in the cycle. As of this writing, Canadian futures markets are pricing in another ~1.5 hikes by the end of 2023.

3. Liquidity drainage continues with the Fed’s balance sheet unwinding and the Treasury General Account (TGA) continuing to resupply itself with funds consistent with its policy of US$600-700 billion. While the TGA refill has thus far primarily appeared to come from money market funds reducing their participation in the reverse repo facility, that may change as Treasury continues to ramp up issuance over the course of this year.

¹ Purchasing Managers' Index (PMI) is an indicator of the economic health of the manufacturing sector. A reading above 50 signals economic expansion; below 50 signals contraction
² Yield curve is a line that plots interest rates of bonds having equal credit quality but differing maturity dates; its slope is used to forecast the state of the economy and interest-rate changes. 
³ Reverse repo is a security sold with an agreement to repurchase that same security at a specified price at an agreed upon time in the future. The difference between the sale price and the repurchase price implies a rate of interest paid by the central bank on the transaction.
⁴ Reaction function is a contingency plan for how a central bank will react to certain events or data releases. 
⁵ Core/core plus typically invest in a baseline of investment-grade bonds such as government, corporate, and securitized debt. Core plus funds can take that baseline, and add additional sectors such as corporate high-yield, emerging-market debt, or non-US currency exposures to enhance returns.
⁶ Carry is the difference between the yield on a longer-maturity bond and the cost of borrowing.
⁷ Duration is a measure of the sensitivity of an investment’s price to nominal interest-rate movement.
⁸ Securitized credit involves pooling a large number of loans into an investable asset. Examples include mortgage-backed or asset-backed securities.
⁹ Spreads are the difference in yields between two fixed-income securities with the same maturity, but originating from different investment sectors.
¹⁰ A basis point is a unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indices and the yield of a fixed-income security. 

Global Aggregate is represented by the Bloomberg Global Aggregate Index, a broad-based measure of the global investment-grade fixed-rate debt markets. Euro Aggregate is represented by the Bloomberg Global Aggregate Index - European Euro, which includes fixed-rate, investment-grade Euro denominated bonds. UK Aggregate: Bloomberg Global Aggregate Index - United Kingdom which includes fixed-rate, investment-grade sterling-denominated bonds. US Aggregate: Bloomberg US Aggregate Bond Index is composed of securities from the Bloomberg Government/Credit Bond Index, Mortgage-Backed Securities Index, Asset-Backed Securities Index, and Commercial Mortgage-Backed Securities Index. US Fixed MBS: Bloomberg Agency Fixed-Rate MBS Index tracks fixed-rate agency mortgage backed passthrough securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). US CMBS: Bloomberg CMBS ERISA Eligible Index, which measures the performance of investment-grade commercial mortgage-backed securities, which are classes of securities that represent interests in pools of commercial mortgages. The index includes only CMBS that are Employee Retirement Income Security Act of 1974. US ABS: Bloomberg Asset-Backed Securities Index, the ABS component of the Bloomberg US Aggregate Index, which has three subsectors: credit and charge cards, autos, and utility. US IG Corporates: Bloomberg US Corporate  Bond Index covers all publicly issued, fixed rate, nonconvertible, investment-grade debt. US Corporates Aaa: Bloomberg Aaa Corporate Index designed to measure the performance of investment-grade corporate bonds that have a credit rating of Aaa; US Corporates Aa: Bloomberg Aa Corporate Index; US Corporates A: Bloomberg A Corporate Index, designed to measure the performance of investment-grade corporate bonds that have a credit rating of Aa; US Corporates Baa: Bloomberg Baa Corporate Index; designed to measure the performance of investment-grade corporate bonds that have a credit rating of Baa; US High-Yield Corporates: Bloomberg US Corporate High Yield Index is an unmanaged broad-based market-value-weighted index that tracks the total return performance of non-investment grade, fixed-rate, publicly placed, dollar denominated and nonconvertible debt registered with the Securities and Exchange Commission. Global IG Corporates: Bloomberg Global Credit - Corporate Index is an unmanaged index considered representative of fixed rate, non-investment grade debt of companies in the US, developed markets, and emerging markets. Emerging-Markets Debt: Bloomberg Emerging Markets Hard Currency Index includes USD-denominated debt from sovereign, quasi-sovereign, and corporate EM issuers. Bank Loans: LSTA Leveraged Loan Index, which is a market-value-weighted index that is designed to measure the performance of the US leveraged loan market based upon market weightings, spreads, and interest payments. JP Morgan Emerging Markets Bond Index Global Index is a broad-based, unmanaged index which tracks total return for external currency denominated debt (Brady bonds, loans, Eurobonds and US dollar-denominated local market instruments) in emerging markets. Bloomberg US MBS Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).

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Important Risks: Investing involves risk, including the possible loss of principal. • Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Investments in high-yield (“junk”) bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. • Mortgage-related and asset-backed securities’ risks include credit, interest-rate, prepayment, and extension risk. The value of the underlying real estate of real estate related securities may go down due to various factors, including but not limited to strength of the economy, amount of new construction, laws and regulations, costs of real estate, availability of mortgages, and changes in interest rates. • Loans can be difficult to value and less liquid than other types of debt instruments; they are also subject to nonpayment, collateral, bankruptcy, default, extension, prepayment and insolvency risks. • Foreign investments may be more volatile and less liquid than US investments and are subject to the risk of currency fluctuations and adverse political, economic and regulatory developments. These risks may be greater, and include additional risks, for investments in emerging markets. • Diversification does not ensure a profit or protect against a loss in a declining market.

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