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We will continue to provide regular multi asset, market-specific outlooks. As always, tactical changes to asset allocations should consider investment timeframes, risk profiles and liquidity needs.
Monthly Macro Digest
To stay defensive, investors may consider continuing to move down the duration spectrum in fixed income. This can be implemented in a variety of ways. We currently prefer the short end of the curve including cash and equivalents, multi-sector, microshort and ultrashort and short-term investment grade and high yield sectors. We also prefer defensive dividend paying strategies in the current environment.
If investors are confident that rate increases will be orderly, it may be worth considering how to leg into longer duration positions as rates rise and interest rate risk diminishes. Moving too late may result in a meaningful opportunity cost. In addition, as multiples decline there may be an opportunity to selectively return to growth equities when buying opportunities present themselves.
The coming months are critical as a hawkish Federal Reserve battles stubborn inflation
To date, 2022 has proven that uncertainty can influence markets more than known positives. A mostly resilient economy has not been enough to counter higher inflation, global central bank tightening and geopolitical disruptions. While we would not be surprised by a counter-trend rally in both stocks and bonds, we expect continued volatility in the coming months, and are maintaining defensive positions across asset classes, including shortening duration and incorporating floating rate strategies.
Professional investors have been divided in their views of direction and conviction of markets. As the Fed acts on rates, we are watching the data progression to gauge which of the following scenarios are most likely to play out.
Scenario one, a market-friendly soft-landing, remains possible if the Fed is able to hike enough to slow growth and tame inflation without causing a recession. Scenario two is a hard landing with the Fed forced by persistent inflation to hike enough to cause a traditional recession. Scenario three is notorious but rare stagflation—the Fed hikes enough to cause a recession, but continued supply-side problems drive elevated inflation.
The burning question is what to do as events unfold. A variety of factors will influence outcomes over the coming months, including inflation related reports and uncertainties related to the war in Ukraine and China’s COVID zero policies. It is hard to see how investors can plan for any one scenario.
In summary, while considering investment horizon and risk tolerance, we recommend the following:
Stay defensive for now – Shorten duration, floating rate, and defensive dividend paying equities. Think credit exposure on the short end.
Consider legging into longer-duration selectively as rates rise or and/or the likelihood of further, unanticipated increase diminishes.
Consider flexible, multi-sector strategies, which provide broad exposure and the ability to tilt in a variety of directions as conditions change.
Be present when the rotation back to growth occurs.
Leverage active management when is heightened risk and lower expected returns.
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DISCLOSURES
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risks, and may be more volatile than investment grade securities.
Foreign investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.
Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.
Past performance is no guarantee of future results. Index performance is for illustrative purposes only and is not representative of any specific investment.
Views are as of the dates above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
For additional information, including definitions of related terms and indexes, see the Financial Glossary and Benchmark Index Glossary.
Although the information provided has been obtained from sources which Federated Hermes believes to be reliable, it does not guarantee accuracy of such information and such information may be incomplete or condensed.
The value of equity securities will rise and fall. These fluctuations could be a sustained trend or a drastic movement.
Prices of emerging markets securities can be significantly more volatile than the prices of securities in developed countries and currency risk and political risks are accentuated in emerging markets.
There are no guarantees that dividend paying stocks will continue to pay dividends. In addition, dividend paying stocks may not experience the same capital appreciation potential as non-dividend paying stocks.
Secured Overnight Financing Rate (SOFR): a broad measure of the cost of borrowing cash that is collateralized by U.S. Treasury securities. The New York Fed publishes SOFR on a daily basis.
Value stocks may lag growth stocks in performance, particularly in late stages of a market advance.
Growth stocks are typically more volatile than value stocks.
The value of some mortgage-backed and asset-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private guarantee and/or insurance, there is no assurance that private guarantors or insurers will meet their obligations.
Variable and floating rate loans and securities generally are less sensitive to interest rate changes but may decline in value if their interest rates do not rise as much or as quickly as interest rates in general. Conversely, variable and floating rate loans and securities generally will not increase in value as much as fixed rate debt instruments if interest rates decline.
50785 (2/23)
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With consumers chugging along, getting to the Fed’s 2% target, if possible, could require a lot of pain, an outcome markets aren’t pricing. That was the takeaway from January’s PCE numbers, which disappointed across the board, raising odds of a 50 basis-point move when policymakers meet next month. In other words, after a decade of lower for longer, higher for longer may be taking root.
While “Jobs Friday” doesn’t come until next week, this week offers reams of data that should shed further light on an economy’s health (and indirectly the Fed’s rate path). February ISM data on services and manufacturing, final S&P Global PMIs on both, and Conference Board consumer confidence are on the docket, as well as January readings on pending home sales and durable goods orders.
We still favor overweight exposure to Value/dividend payers and an underweight to Growth in our Equity models, as well as overweights to Developed and EM International on valuations and fundamentals. In Fixed Income, we like EM as well but remain defensive in most sectors. Trade finance, bank loans and residential MBS offer tactical opportunities, as do duration and the yield curve. In fact, we shifted a little longer on duration last week after significant cheapening (rising yields) since January. In Liquidity, we believe substantial cash exposure and tactical positions in short-term products continue to work.
The outlook remains challenged as higher inflation, supply chain constraints, the war in Ukraine and China’s Covid policies weigh on estimates for future GDP and earnings growth. As we approach the start of 2Q22 earnings season, we are preparing for companies to lower full-year 2022 estimates. Business and consumer confidence is falling. Rising global bond yields, especially among peripheral European countries, such as Italy and Greece, are putting pressure on European banks, limiting their ability to lend. The majority of global central banks are reversing decade long loose monetary policies and quantitative easing programs, though the Peoples Bank of China and Bank of Japan remain accommodative. Both Europe and China are a mess, and global PMIs indicate manufacturing and service sectors are rapidly slowing, with elevated inflation likely to cut into consumer demand in Q3.
International economy:
The combination of sharply higher inflation, plunging business and consumer confidence, slower economic growth and the need for continued aggressive tightening from the Fed collectively increased stagflation concerns among investors in June. Nominal CPI inflation hit a new 41-year high at 9.1%, while the Michigan Consumer Sentiment Index plunged to a record low. The labor market, consumer spending, housing and manufacturing have all been strong, but they are showing signs of decelerating growth. At the same time, the Fed is now appropriately and aggressively raising interest rates to combat inflation, with the Phillips Curve trade-off being a potential increase in unemployment and slower economic growth.
International equity:
U.S. economy
International economy
U.S. equity
International equity
Fixed income
Liquidity
U.S. equity:
After declining by 20% in this year’s first half (the worst performance since 1970) the S&P 500 soared nearly 9% in July, marking its best performance in a single month since November 2020. Since mid-June, it has surged by more than 13%. Growth stocks have outperformed value stocks by more than 7% over the past six weeks, erasing nearly half of their 15% underperformance during the first half of 2022. But the upcoming second-quarter earnings season could be a challenge. We expect stocks to relinquish recent gains over the next few months.
U.S. economy:
Developed international stocks rallied 4.9% in July, balancing favorable valuations against recession concerns in Europe, where the prolonged Russia-Ukraine conflict is threatening supplies and driving up prices for oil, gas and agricultural commodities. Emerging markets equity failed were -0.25 in July. High energy and commodity prices are benefiting resource-and-ag exporters such as Brazil but hurting resource-and-ag importers such as India.
Fixed income:
Bond markets are now focused on recession risk from the inflation surge, the Fed’s massive tightening and the negative shock to real incomes. Consequently, the one-way trade where high inflation prompts higher yields appears to be over. Inflation is global, and international central banks are battling similar dynamics. International bonds remain under historic pressure, in particular in local currencies as the dollar has rallied universally.
Liquidity:
The important question facing the broad liquidity market is when the short end of the Treasury yield curve and commercial paper rates will peak in anticipation of when the Fed will pause and potentially ease.
Macro Dashboard—Inflation roiling
developed markets
Returns Dashboard YTD
as of 07/29/2022
Indices quoted on Total Return Basis
As of 8/02/2022
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Feb. 27, 2023
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Maintain shorter durations while also capitalizing on opportunities slightly further out the curve.
Maintain a general preference for higher-quality securities given risk of an economic slowdown.
Take a more balanced approach to floating-rate securities leading up to a Fed pause.
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Asset-backed securities
Liquidity
Liquidity
As of 2/28/2023
0.41%
-0.15%
2.47%
0.43%
Total returns
U.S. Aggregate
Global Aggregate
U.S. Corporate HY
S&P Municipal Bond
During the last two weeks of February, the 2-year Treasury yield jumped 70 basis points to 4.8%, while the 10-year yield rose by more than 50 basis points to 3.9%. The respective moves pushed the 2s/10’s yield curve inversion to 90 basis points, the steepest inversion since 1982. The sharp move higher in yields has been driven by a consistent stream of hotter-than-expected economic data, prompting markets to shift from underpricing to pricing in, if not overpricing, the Fed’s hawkish narrative. Don’t fight the Fed is a market mantra for a reason.
One change to our outlook has been the expectation of somewhat lower longer yields in months to come, resulting in a slightly longer duration call. There are multiple factors supporting opposing directions in yields and contributing to recent price volatility. In short, persistent inflation likely drives further central bank tightening, potentially driving rates higher particularly on the shorter end, while subsequent growth deceleration, and possible geopolitical events, could push longer rates lower.
Globally, we expect central banks to become less hawkish as inflationary pressures cool. Commodity prices are anticipated to remain robust, but global supply chains continue to heal with an easing of bottlenecks. The awaited reopening of China is a plus for both developed and emerging market debt.
Positioning
Our fixed-income committees are slightly long benchmark duration and effectively neutral the yield curve and the U.S. dollar. As far as sectors, our portfolio models are underweight investment grade, high yield and overweight international developed emerging markets, U.S. Treasuries and agencies, with tactical positioning in residential MBS, where we currently are overweight as the coupon is attractive. We expect company-specific results to drive corporates including high yield in a mostly difficult earnings environment. We believe municipal bonds are offering an improved risk/return balance for investors in spite of a drop in February.
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European Central Bank
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High Yield
Fixed income
Fixed Income
As of 2/28/2023
3.40%
7.89%
9.45%
5.87%
0.92%
Total returns
S&P 500
Russell 2000
NASDAQ
MSCE EAFE
MSCI EM
U.S. Equities
Domestic equity markets cooled in February with results varying across categories, with small caps and the Nasdaq Composite faring better than the large-cap Dow and S&P 500. Major indexes remain much improved from their 2022 lows, but the February retrace reflected a return to fundamentals as fourth-quarter earnings underwhelmed.
The macro environment remains confounding. Positive economic prints are negatives with equity markets vulnerable to continued Fed hawkishness. Volatility throughout February added to gloomy predictions about new market bottoms, but we have established our 2024 outlook with a broad range for the S&P 500 and believe earnings and valuations still have significant downside to work through. Markets don’t like uncertainty and a unique combination of factors is in play with resolution a ways off.
International Equity
The January rally in developed and emerging markets also corrected in February. Rising prospects for a higher-for-longer Fed fueled a rally in the dollar, partially reversing a four month sell-off. This created headwinds for some emerging markets despite China’s reopening. At the same time, valuations are more attractive internationally, and the range and severity of inflation varies across markets. While global equity returns were highly correlated in 2022, 2023 has the potential to provide nuanced pockets of opportunity driven by growing demand in a reopening China and a USD that shows signs of coming off a recent surge going forward.
Positioning
We continue to prefer defensive dividend-paying stocks and are underweight rate-sensitive growth stocks. We’re more constructive on international large cap and emerging markets. We remain defensive in the U.S., preferring value and dividend-oriented equities even while acknowledging January’s rally in riskier categories. We believe more rate and economic pieces need to be in place for a value-to-growth rotation to have legs.
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Emerging Markets
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Year-to-Date
Equities
Equities
International economy
The one-year anniversary of the invasion of Ukraine passed with estimates of nearly a quarter million dead and the conflict may be far from over. Meanwhile, the economic outlook for Europe has improved in the last few months. Natural gas prices are sharply lower from last summer’s peak, abetted by mild winter temperatures. But preparedness for the war’s fallout and the long tail of the Covid-recovery dynamics also have underpinned economic resilience on the continent. European governments targeted fiscal measures to shield households from large increases in utility bills, and made sure that gas storages were plentiful before the winter season. We now expect eurozone real GDP growth of 0.6% in 2023, up from last winter’s projections. Going forward, the eurozone cycle is sensitive to what happens in the U.S. If the U.S. falls into a recession in the second half of 2023, the eurozone likely will follow with a lag that typically is in the range of two to three quarters, presenting a more sobering picture for the eurozone and the global economy overall later in 2024.
Despite geopolitical drama over balloons and potential support of the Russian war effort, China’s rapid reopening and abandonment of Covid lockdowns has consensus expecting a marked improvement in growth and a return to normal. To drive the recovery, China has loosened the regulatory net on enterprises and boosted the money supply, and has policy options including direct payments to consumers and quantitative easing used by other countries post-pandemic at its disposal. China's reopening may lift global growth, but we expect a limited and temporary impact as much of its focus will be internal.
Jobless
3.40
6.60
5.50
2.50
3.70
Inflation
6.40
8.60
2.10
4.30
10.10
Interest Rate
4.75
3.00
3.65
-0.10
4.00
GDP QoQ
2.90
0.10
0.00
-0.20
-0.30
GDP YoY
0.90
1.90
2.90
0.60
0.40
Country
United States
Euro Area
China
Japan
United Kingdom
As of 2/28/2023
Source: Trading Economics.
Macro Dashboard—Inflation roiling developed markets
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Gross Domestic Product
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Gross Domestic Product
U.S. economy
February provided support to the higher-for-longer camp as inflation remained sticky, seasonally adjusted January jobs surprised to the upside and fed futures adjusted toward a higher terminal rate around 5.25-50%. Robust January job growth, consumer spending and services activity, along with higher-than-expected PCE and CPI prints, were the culprits. The good news is bad news conundrum persists, keeping pressure on the Fed to cool the economy the hard way. Consensus now sees a third rate hike in June with any potential rate easing pushed into 2024.
What’s different this time? The past may not be prologue—the unique economic environment spawned by unprecedented fiscal and monetary stimulus due to a pandemic may not align with traditional analysis and forecasts. Current equity markets appear to be underpricing recession risks, while fixed-income markets are increasingly pricing one in. This suggests the rocky landing scenario we’ve been presenting for a while, one that sees a slowdown rolling through individual parts of the economy non-sequentially, could well be what happens. Not ultimately a technical recession, but plenty of bumps along the way.
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Basis of Estimate
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Personal Consumption Expenditures
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Gross Domestic Product
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Consumer Price Index
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United States
Economies
Economies
Liquidity
Fixed Income
Equities
Economies
February 2023
Monthly
Resources
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United States
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United States
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Standard & Poors
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United States
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Mortgage-Backed Securities
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United States
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United States
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United States
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United States
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United States
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Standard & Poors
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Emerging Markets
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Job Openings and Labor Turnover Survey
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Emerging Markets
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Gross Domestic Product
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Gross Domestic Product
Our current base case is a rocky landing with a few negative GDP quarterly prints over the next 12 months, making for a technical if not overly deep recession. This scenario favors continued defensive positioning across Equities, Fixed Income and International. In Liquidity, we prefer a heightened exposure to cash, which now provides a reasonable yield, and short-duration products. With the U.S. 10-year now testing 4%, we are likely getting close to becoming more constructive on longer-duration Treasury bonds, while having a more cautious view of credit.
Positioning
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Federal Open Market Committee
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United Kingdom
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United States Dollar
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Year to Date
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Federal Open Market Committee
As of 2/28/2023
4.52%
4.65%
4.88%
5.17%
5.02%
Short-term yields
SOFR 30-Day Avg
1-month T-Bill
3-Month T-Bill
6-Month T-Bill
1-year T-bill
MMDA Avg
First Tier IS Avg
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Consumer Price Index
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Secured Overnight Financing Rate
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Money Market Deposit Accounts
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Institutional
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United Kingdom
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United Kingdom
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United States
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Emerging Markets
Source: Bloomberg
Source: FRED®, U.S. Treasury, Bloomberg, iMoneyNet
Source: Bloomberg
Source: Fred®, U.S. Treasury, Bloomberg
Source: FRED®, U.S. Treasury, Blomberg
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Federal Open Market Committee
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Gross Domestic Product
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Fourth Quarter
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Private Mortgage Insurance
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United States
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Gross Domestic Product
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Mortgage-Backed Securities
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Standard and Poor's
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Institute of Supply Management
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United Kingdom
Fed futures contracts still appear to be pricing cuts to the federal funds target rate at the end of 2023, but we don’t expect that to happen. Work still needs to be done to get inflation under control. We are keeping our finger on the pulse of the developing U.S. debt limit debate, but ultimately believe it will be resolved and do not expect the U.S. government to default on its debt obligations.
Positioning
We expect the Fed to move forward with rate hikes at the next several meetings before pausing, with the recent reacceleration in inflation data posing some risk to that forecast. For now, investing incrementally shorter can be beneficial, but we are finding more attractive opportunities in the ultrashort space, particularly in higher-quality securities.
Three themes are guiding our investment views in the space:
Maintain shorter durations to limit interest rate risk as the Fed continues to hike rates.
Continue credit exposure in the money market space, while focusing on higher quality securities further out the curve.
Less positive on floating rate securities than previously due to slowing rate expectations for 2023.
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Emerging Markets
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European Central Bank
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Standard & Poors
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Standard & Poors
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United States
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United States
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Emerging Markets
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Price-to-Earnings
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Price-to-Earnings
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Earnings Per Share
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Personal Consumption Expenditures
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Fourth Quarter
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Mortgage-backed Securities
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Emerging Markets
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European Central Bank
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Gross Domestic Product
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United States
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Gross Domestic Product
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Emerging Markets
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Emerging Markets
Short-term yields
SOFR 30-Day Avg
1-month T-Bill
3-Month T-Bill
6-Month T-Bill
1-year T-bill
MMDA Avg
MM First Tier IS Avg
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Money Market
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Private Mortgage Insurance
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Emerging Markets
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Standard & Poors