Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks
In the latest developments from the Federal Reserve, New York Fed President Williams and Minneapolis Fed President Kashkari have voiced a shared caution regarding the near future of U.S. monetary policy. Despite a softening Core PCE index and more than half of the US CPI components registering below 2% YoY for the first time since 2020, both Williams and Kashkari emphasized the necessity of waiting for more substantial data confirming that inflation is consistently moving towards the Fed's 2% target before contemplating rate reductions. Williams highlighted that the high borrowing costs are effectively tempering economic activities, projecting inflation to decrease in the second half of 2024, while Kashkari pointed to robust wage growth and a strong labor market as justifications for maintaining the current restrictive policy stance. Adding to the mix, Dallas Fed President Lorie Logan, known for her hawkish views, suggested that the current high interest rates might not be restraining the economy as much as anticipated, implying that the neutral rate could be higher than pre-pandemic levels. Logan stressed the importance of flexibility in policy decisions, underscoring it’s too early to consider rate cuts and the need to keep all options open due to the ongoing economic robustness. Across the Atlantic, the European Central Bank is poised for a cautious start to monetary normalization at its upcoming meeting. Although a rate cut is expected—market odds are at 98% for the first reduction 260 days after the initial hike—the ECB aims to carefully balance inflation control with economic growth support. With European wages remaining elevated, particularly in the services sector, and inflation plateauing, the ECB's path to the neutral rate promises to be a measured and vigilant one. In Japan, concerns over a prolonged and excessive weakening of the yen have stirred discussions about a potential preemptive rate hike. BoJ Board member Adachi highlighted that monetary policy adjustments could be considered to counteract inflationary pressures arising from the yen’s depreciation, with the market now anticipating a rate hike as soon as July 31st. Meanwhile, in the UK, amidst ongoing economic adjustments and market evaluations, the anticipation for an initial rate cut has been pushed to November, reflecting a cautious approach as policymakers navigate through complex economic signals. Overall, global central banks appear united in their cautious stance, opting to prioritize data-driven approaches to ensure their respective economies are on a stable path towards recovery and inflation targets.

May showed continuing robust sentiment in the credit market, albeit with minor signs of deterioration. US Investment Grade corporate bonds closely mirrored the performance of US Treasuries, ending the month with spreads slightly tighter by 2 bps at 85bps. This stability supported a solid 1.6% gain for the Vanguard USD Corporate Bond ETF. Despite these positive indicators, the US primary market experienced a slight dip in enthusiasm, with new issuance being 3.7x oversubscribed compared to 4.2x in April and a year-to-date average of 3.8x. Nonetheless, 78% of these new issues saw their spreads tighten by an average of 6 bps shortly after entering the secondary market, indicating continued investor confidence. However, a shift in credit quality was noted, as there are now more BBB-rated bonds with a negative outlook than those with a positive one for the first time since 2022. This change points to increasing risk perceptions within the $8.9 trillion high-grade US corporate bond market. In the high-yield segment, the IShares Broad USD High Yield Corporate Bond ETF managed a gain of 1.7%, though the sector saw credit spreads widen by 10 bps to 310 bps. Despite this widening, high-yield new issues were well-received, tightening by 13 bps on average in the secondary market, showcasing a healthy appetite for riskier assets. Across the Atlantic, European credit markets also tightened, particularly benefiting from a partial recovery in CCC-rated bonds. Investment Grade spreads in Europe narrowed by 5 bps to 108 bps, the lowest since February 2022. This tightening helped offset the negative returns driven by rising European interest rates, allowing the iShares Core Euro IG Corporate bond ETF to finish the month up by 0.3%. High beta credit instruments saw notable performance improvements, with the iShares Euro HY Corporate bond ETF gaining 0.7% thanks to a 35 bps tightening in spreads. European corporate hybrids also fared well, benefiting from Moody’s recent methodology updates for hybrid notes, which led to a 0.9% gain. The standout performer in the European credit scene in May was the AT1/CoCo bonds, with the WisdomTree AT1 CoCo Bond ETF achieving a 1.5% gain, highlighting the strong demand for higher-yielding, riskier credit instruments as investors continue to search for attractive returns.


May was a notable month for global treasuries, with significant gains particularly seen in US and UK government bond markets. U.S. Treasuries experienced an excellent performance, aided by less resilient economic activity than expected. The downturn in the US Citi Economic Index and a moderation in US PCE core inflation to 2.75% yoy provided some relief, allowing US rates to stabilize by month's end. The 10-year US Treasury yield saw a decline of almost 20 bps to 4.50%, primarily driven by decreases in US real rates while US breakeven rates fell by 5 bps. This favorable environment led to a strong performance of the iShares 3-7 Year Treasury Bond ETF, which posted a gain of 1.8%, and longer-term bonds rising nearly 3.0%. Similarly, the UK bond market also enjoyed positive outcomes, with instruments such as the BB Series-E UK Govt 1-10 Yr Bond ETF increasing by 0.6% and the Vanguard U.K. Gilt long duration ETF climbing by 0.8%. These gains reflect growing investor confidence and a positive shift in market sentiment towards UK government bonds. However, the scenario was less optimistic in Japan and Europe, including Switzerland. Despite ongoing economic recovery efforts in Europe, inflation rates have started to plateau, which has slightly dampened the prospect for extensive rate cuts in 2024. This sentiment was reflected in the 10-year European swap yield which rose by 5 bps to 2.90%, while core rates such as the 10-year German yield also increased by nearly 10 bps to 2.66%. The month ended with the iShares EUR Govt bond ETF down by 0.3%. In Switzerland, a rebound in economic activity and higher than expected inflation numbers caused the 10-year Swiss yield to increase by 17 bps to 0.93%. The Japanese government bond market faced the harshest conditions, particularly at the longer end of the yield curve. The 30-year Japanese yield rose about 30 bps, ending the month at 2.23%, marking its highest level since 2011. The month concluded with a noteworthy development as S&P downgraded France's sovereign credit rating to AA- late on the final Friday of May, pointing to concerns over a widening fiscal deficit and challenges in implementing fiscal corrections.

Emerging market

May witnessed a commendable performance in the Emerging Markets bond sector, with the Bloomberg Emerging Markets Hard Currency Aggregate Index climbing 1.7%. This rise was underpinned by strong gains across various segments of the market. Sovereign bonds, particularly, leveraged their longer duration to register a notable increase, with the iShares Emerging Market Sovereign Bonds ETF rising 2.6%. Corporate bonds also showed impressive dynamics, with the iShares Emerging Market Corporate Bonds ETF gaining 2%, highlighting investor confidence in the corporate sector of emerging economies. Credit spreads in Emerging Markets corporate bonds continued their tightening trend, decreasing by 15 basis points to close the month at 208bps. This is the lowest level since 2007, reflecting a growing investor appetite for emerging market debt. Additionally, Emerging Markets local debt enjoyed a boost, up 2.3%, primarily due to a weakening US Dollar which enhances the local currency returns for dollar-based investors. In Asia, optimism about economic prospects increased as the International Monetary Fund (IMF) revised its growth projection for China in 2024 to 5% from an earlier forecast of 4.6%. This revision contributed to a robust month for credit in the region. Investment Grade (IG) spreads in Asia tightened by 7 basis points to 78bps, while High Yield (HY) spreads saw a significant compression of 64 basis points to 421bps, signaling strong recovery momentum and investor confidence in Asian markets. Latin America is also witnessing significant political developments with Mexico poised to elect its first female president on June 2. Claudia Sheinbaum and Xóchitl Gálvez, both leading in the polls, represent a significant shift in the political landscape. Sheinbaum, from the left-wing populist governing alliance, is favored to win, which could herald changes in Mexico's economic policies and potentially impact the market dynamics in the region. Furthermore, S&P has upgraded India's outlook to Positive, adding an optimistic tone to the financial environment ahead of the upcoming election. This upgrade reflects improved confidence in India's economic stability and growth potential, although it remains to be seen how this optimistic outlook will align with the electoral outcomes and their subsequent impact on economic policies and market conditions.

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

Soaring German Real Yields as ECB Rate Decision Approaches!


Source: Bloomberg

As the European Central Bank gears up for its meeting, which is widely anticipated to result in the first rate cut since March 2016, the dynamics in the European bond market are particularly intriguing. German real yields, which adjust nominal yields for inflation expectations, have hit their highest levels of this cycle. This surge is notable as it comes at a time when long-term inflation expectations in Germany are stabilizing around the ECB’s target of 2.1%. This rise in real yields is a significant marker of increasing borrowing costs across Europe, making financing more expensive. However, this may not necessarily alarm the ECB. In fact, higher real yields could be seen as a positive development, reflecting stronger economic fundamentals and a recovery taking root across Europe. The key question now is: how high can real yields climb before they begin to weigh on Europe’s economic recovery?


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