Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks

Last week, the central banks of the European Central Bank (ECB) and the Bank of Canada made significant moves by initiating a new phase in their monetary policies, easing some of their restrictive measures. The ECB made a cautious step by reducing its key interest rates by 0.25% for the first time since December 2019. Despite this cut, the ECB adopted a hawkish stance by avoiding any commitments to future actions. The Governing Council emphasized a data dependent, meeting-by-meeting approach, reducing the likelihood of a back-to-back rate cut in July due to insufficient European data before the next meeting. This strategy is seen as a "hawkish cut," and the market has adjusted its expectations, now foreseeing fewer than two rate cuts for the rest of the year, possibly one each in September and December. In contrast, the Bank of Canada, facing an inflation rate of 2.7% and an economy that is more sensitive to interest rate changes than the US, also reduced its key interest rate by 25 basis points. However, the BoC has left the door open for another potential rate cut in July without committing outright, with the market assessing a more than fifty percent likelihood for this additional cut. Looking ahead, the focus shifts to the United, where the Federal Reserve is expected to announce its latest monetary policy decisions next week. A critical element to watch will be the Dot Plot, which will provide insights into the Fed's expectations for the number of rate cuts in 2024, previously indicated as three during the March meeting. It will also offer clues on the perceived neutral rate, which is currently seen as the potential terminal rate for this cycle, set at 2.56%. Market expectations are currently split, predicting one to two rate cuts by the end of the year. Meanwhile, in Japan, the Bank of Japan is also scheduled to release its monetary policy decisions. While no changes in interest rates or reductions in bond-buying are anticipated, a more hawkish tone is expected to stabilize market expectations.


Last week, the U.S. credit markets experienced a slight strain with investment-grade credit spreads widening by 3 basis points. Despite this widening, the drop in interest rates allowed the Vanguard USD Corporate Bond ETF to post a gain of 0.6%. On the other hand, the U.S. high yield market remained relatively stable, with the iShares Broad USD High Yield Corporate Bond ETF showing a marginal increase of just 0.1%, reflecting its shorter duration and less sensitivity to rate fluctuations. Volatility in U.S. credit spreads stayed near historical lows, indicating a continued investor comfort with the risk levels in the credit market. Over in Europe, the situation was somewhat steadier. European credit spreads showed little change, with a minor tightening observed in the high-yield segment. The iShares Core EUR Corporate Bond ETF remained flat over the week, while the iShares Euro HY Corporate Bond ETF appreciated by 0.4%, bringing its year-to-date gain to 1.2%. Interestingly, the European high-yield market was particularly active in the primary market during May, witnessing an issuance volume of EUR 12 billion—double the five-year historical average of EUR 6 billion. This indicates a robust appetite for riskier assets despite the broader market uncertainties. Rounding out the week, the more niche segments of the European credit market, specifically corporate hybrids and AT1 bonds, saw modest gains. The Invesco Euro Corporate Hybrid ETF inched up by 0.1%, and the WisdomTree AT1 CoCo Bond ETF increased by 0.2%, both benefiting from the slightly improved market sentiment.


Last week, the US bond market was anything but calm, highlighting just how dynamic and unpredictable it can be. US government bond yields saw a significant drop from 4.65% to 4.27% in just six days, driven by a variety of factors. However, this downtrend was abruptly halted by stronger-than-expected US payroll figures, causing yields to jump by an average of 15 bps on Friday alone. By the week's end, the 10-year US Treasury yield settled at 4.43%, down 6 bps from the previous week, while the 2-year yield slightly rose by 3 bps to end at 4.89%. Amidst this, the yield curve remains inverted by 45 bps, signaling mixed sentiments about future economic conditions. Alongside a drop in oil prices, US breakeven rates—a measure of market inflation expectations—also fell across various maturities: 10 bps for 2-year, 7 for 5-year, and 5 for 10-year. This contributed to the 10-year US Treasury real yield rising above 2%, to 2.13%. Despite these fluctuations, the MOVE index, which gauges interest rate volatility, maintained a level below 100 for the fifth consecutive week, reflecting a somewhat stable volatility landscape in the bond market. The iShares USD Treasuries ETF managed a 0.4% gain for the week, although it remains down 1.5% for the year. The dynamics of supply and demand for US Treasuries continue to concern investors. Notably, there's speculation that the Bank of Japan may have sold some US Treasuries to support its currency intervention efforts. Furthermore, according to Bank of America, bond allocations for their private clients are at 20%, still below the historical average (25%) and far from the peak of 35% seen in 2009. In Europe, post-ECB decision effects were more muted. European bond yields edged higher across maturities without significant shifts in peripheral rates. Inflation forecasts for 2024 and 2025 in Europe have been revised upwards, prompting expectations that the ECB will keep interest rates higher for longer—likely above the neutral rate for the next 12 to 18 months. German bond yields displayed mixed movements: while short-term bonds remained stable, intermediate and long-term yields experienced a slight decrease of 5 basis points. Consequently, the iShares Core EUR Government Bond ETF saw a modest increase of 0.2% last week. Over in Japan, the 10-year yield has retreated below 1% after the Bank of Japan opted not to reduce its bond-buying program last week, providing some stability in Japanese bond markets amidst ongoing economic pressures

Emerging market

Emerging markets were at the forefront of financial news last week due to significant electoral developments in India and Mexico, both of which have had considerable implications for the markets. In Mexico, Claudia Sheinbaum's election as the first female president has been seen as a continuation of the current administration's policies under Andrés Manuel López Obrador. Despite this continuity, the financial markets reacted negatively to her significant win and her party's commanding majority in Congress, which stoked fears about potential extensive constitutional changes that might adversely affect economic growth and fiscal stability in the medium term. Following the election results, Mexico's sovereign and quasi-sovereign bond spreads widened, the Mexican stock market experienced a sharp decline of 5-10%, and the peso depreciated by approximately 4% against the U.S. dollar. In India, the election outcome was unexpectedly tight, with Prime Minister Narendra Modi's ruling Bharatiya Janata Party securing a narrower margin of victory than anticipated. This close result is likely to influence the government's approach to fiscal policies, potentially slowing down efforts aimed at fiscal consolidation. The administration might increase populist spending to strengthen voter support, which could delay the improvements necessary for an upgrade of India’s sovereign rating. S&P had recently improved its outlook to Positive from Stable, but the electoral results may complicate this trajectory. Amid these political shifts, emerging market financial instruments displayed mixed responses. EM corporate bonds managed to eke out a slight gain, with the Bloomberg EM Corporate Bond Index rising by 0.2%, showing some resilience amidst broader market volatility. However, EM sovereign bonds did not fare as well, recording a slight loss of 0.2%. More significantly, EM bonds denominated in local currencies suffered losses close to 1% over the week.

Our view on fixed income (June)


For government bonds with maturities of less than 10 years, we turn positive. This position is supported by the presence of high real yields, an anticipated peak in central bank’s tightening, a shift towards disinflation, their relative value when compared to equities, and an improvement in correlations. On the other hand, we exercise caution towards bonds with maturities exceeding 10 years. The presence of an inverted yield curve and negative term premiums diminishes their appeal, especially amidst ongoing interest rate volatility.


Investment Grade
We are more cautious on IG corporate bonds. The sharp tightening in credit spreads, reaching lowest level since 2021, has considerably reduced the margin for safety in credit. Spreads now represent less than 20% in the total yield of an investment grade bond. This “price to perfection” encourages us to be more vigilant in this segment.
High Yield

High Yield (HY) could come under pressure in this uncertain environment. Recession fears, expectations of higher default rates and one of the most aggressive monetary policies are expected to weigh on this segment. The spread of U.S. HY bond narrowed below 300bps, its tightest point since January 2022. This current valuation of U.S. HY spreads implies modest default rates and the absence of inflation slippage, or a near-term recession. We see more value on subordinated debts over High Yield. 

Emerging Markets
We have turned negative on Emerging Marke debt, driven by the strength of the dollar and rising US real yields. EM corporate spreads have reached very tight levels, which considerably reduces the margin of safety. Additionally, there are persistent negative capital flows and an increase in short interest in USD-denominated EM debt, indicating growing market pessimism. However, we still see value in bonds with maturities of up to 4 years and yields exceeding 6.5%.

The Chart of the week

U.S. Yield Curve's Prolonged Inversion!


Source: Bloomberg

The U.S. Treasury yield curve remains strikingly inverted, continuing a trend that has set a market record since it began on July 6th, 2022. Last week, the gap between the 2-year and 10-year yields deepened to -45 basis points. This enduring inversion is primarily driven by the Federal Reserve's robust stance on short-term rates to combat inflation, juxtaposed with long-term bonds priced with expectations of inflation stabilizing around 2%. The market's "higher for longer" outlook has kept the yield curve inverted, as investors speculate on when the Fed might act to shift this trend. With the upcoming FOMC meeting this week, all eyes are on the potential for a dovish shift that could finally influence a steepening of the curve, offering a pivotal moment for bond market dynamics.


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