Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks

As the Federal Reserve enters a blackout period before its May 1st announcement, no immediate rate cuts are expected. The focus is likely to shift towards potentially slowing the pace of quantitative tightening (QT) to ensure sufficient liquidity and ease pressure on Treasury supplies, particularly T-Bills. By the end of the week, the markets had priced in just one rate cut for December. In Europe, the ECB is prepping for its June meeting, where a rate cut is now widely anticipated. However, concerns about a prolonged misalignment with the Fed's policies could impact the euro adversely. ECB member Fabio Panetta has advocated for prompt rate cuts to support the Eurozone economy and avoid the necessity of returning to ultra-low rates if economic stagnation deepens and inflation expectations dip below the 2% target. Although a June rate cut is almost certain, the path for subsequent cuts remains a topic of debate among ECB officials. Vice President Luis de Guindos views the initial reduction as almost certain, provided current trends hold, but remains cautious about further easing due to potential risks from service sector inflation, the US economic outlook, and geopolitical tensions impacting oil prices. In the UK, expectations for the first rate cut have shifted to September, with fewer than two cuts anticipated for the year. The Bank of England's Monetary Policy Committee is divided, with Chief Economist Huw Pill and other hawks calling for a cautious approach due to ongoing inflationary pressures. Pill stresses the risks of easing too soon, while policymaker Jonathan Haskel notes the labor market's tightness suggests delaying rate cuts until inflationary pressures abate more clearly. Meanwhile, the Bank of Japan maintains its supportive monetary stance, continuing to purchase government bonds to keep long-term rates near 1% and short-term rates between 0% and 0.1%. This policy comes as the yen nears a 34-year low against the dollar. The BOJ expects inflation to remain above its 2% target next year but to stabilize by fiscal 2025, with the market anticipating more than two rate hikes in 2024 as conditions evolve.


In the U.S., the credit market experienced a positive week, with Investment Grade (IG) credit spreads tightening by 5 bps. This contraction in spreads effectively offset the adverse effects of rising interest rates, allowing the Vanguard USD Corporate Bond ETF to remain stable over the week. The U.S. IG market was buoyed by a robust primary market, showcasing strong issuance volumes and solid demand. New issue concessions for Financials and Non-financials averaged between 5-7 bps, signaling a return to conditions seen before the recent spike earlier in the year. These concessions are now only slightly above the pre-COVID averages of 2016-2019. In the High Yield (HY) sector, credit spreads narrowed significantly, settling just above 300bps. This marked tightening propelled the iShares Broad USD High Yield Corporate Bond ETF to a +0.8% gain for the week. The U.S. HY market continues to benefit from favorable technicals, including low default rates and diminishing refinancing concerns. Notably, 73% of U.S. HY issuance has been allocated for refinancing purposes. As of the end of March, the 12-month trailing default rate for U.S. HY bonds slightly increased to 4.0% compared to 3.8% at the end of last year. In Europe, the IG market performed comparably to its U.S. counterpart, with the iShares Core EUR Corp Bond ETF showing flat performance due to the offsetting effects of tighter credit spreads and rising interest rates. According to Goldman Sachs, the unwinding of the ECB’s Pandemic Emergency Purchase Programme (PEPP) has been uneventful. Since July 2023, the Corporate Sector Purchase Programme (CSPP) has been reducing its holdings by an average of €2.4 billion per month, with the ECB's total IG holdings decreasing from over €345 billion at its peak in late 2022 to €313 billion today. Despite this significant reduction, spreads have tightened by over 40 bps since the onset of quantitative tightening, with CSPP-eligible bonds outperforming their non-eligible counterparts. The European High Yield market also saw positive movement, with the iShares EUR High Yield Corp Bond ETF gaining +0.5% over the week, recovering from recent idiosyncratic risks such as issues faced by Altice, Intrum, and Ardagh. Like its U.S. counterpart, the European HY market benefits from a strong refinancing focus, with half of the issuance aimed at refinancing, whereas M&A related issuance remains minimal. Default rates for the first quarter ended at 3.5% for HY bonds and 4.4% for leveraged loans, an increase from the end of last year. Notably, 60% of defaults in the European HY space this year have been "soft" (i.e., distressed exchanges), contrasting with the leveraged loan market where 70% of defaults were due to missed payments.


In the U.S., Treasuries ended the week on a high note despite mixed economic signals. The Core PCE index, a crucial inflation measure for the Federal Reserve, held steady at 2.8%, defying expectations of a decrease to 2.7%, and mitigating concerns sparked by a substantial miss in Q1 GDP growth (+1.6% YoY vs. +2.5% expected). The 2-year Treasury yield reached a peak not seen since November 2023 at 5%, while the yield curve (2s10s) steepened slightly by 3bps, buoyed by a robust turnout at a record-sized 2-year UST auction. Looking ahead, no changes are anticipated in the auction sizes at the upcoming May Quarterly Refunding Announcement. The 10-year note yield surged to 4.73%, marking its highest since November 1st, 2023, and closed the week at 4.66%, approximately 100bps above its December 2023 low. The real yield on 10-year US Treasuries ended at 2.24%, the highest since mid-November. The 30-year yield peaked at 4.85% before settling at 4.78% by week's end. Consequently, the iShares US Treasury Bond ETF dipped by -0.25% for the week, contributing to a year-to-date decline of -3.1%, while the long-term US Treasuries ETF (TLT) has fallen by 10% year-to-date. In Europe, expectations of an imminent rate cut in June are influencing the short end of the German bond market, with the 2-year yield decreasing by 2bps to 2.98%. Nonetheless, the long-term outlook remains uncertain due to signs of an economic upturn and persistent service sector inflation, causing a slight steepening of the yield curve as the 10-year German yield climbed by 8bps to 2.58%. Peripheral European bonds, particularly Italian, were favorably received, tightening the spread to German bonds by 8bps to 134bps. Italy’s credit rating was reaffirmed at BBB with a stable outlook by DBRS, underscoring the positive momentum in peripheral debt markets. Moreover, Greece’s successful issuance of a 30-year bond, with demand exceeding supply by eleven-fold, highlights strong market confidence. In the UK, the latest PMI data signaled the fastest expansion in private sector activity in 11 months, propelling the UK's 10-year government bond yield up by 10bps to 4.32%. Furthermore, the DMO unexpectedly revised its financing needs up to £277.7bn for FY 2024-25 from an earlier £265.3bn, adding pressure. This dynamic mirrors the broader global rate environment, where Japanese yields have also increased, with the 10-year bond closing the week at 0.90%, its highest since November 2023. 

Emerging market

Last week saw mixed performance in emerging market debts. The Bloomberg EM Corporate Bond Index slightly rose by +0.1%, while the Bloomberg EM Sovereign Bonds Index dipped by 0.1%. Argentine bonds shined, buoyed by the country posting its first fiscal surplus in 16 years, which helped lift EM $ HY sovereign bonds. Local currency EM debts, however, struggled, dropping -0.7% over the week and tumbling -2.5% since the year's start. This downturn reflects the broader impact of a strong US dollar, exacerbated by delays in the Federal Reserve's policy normalization, which has dampened expectations for the start of rate cuts. The credit spread of EM corporate bonds denominated in US dollars narrowed to 225bps, marking its lowest point since January 2018. In Asia, sentiment is on the rise as economists revise upward their forecasts for China's 2024 GDP growth. Asian Investment Grade (IG) credit spreads have hit record lows, with the Bloomberg Asian IG credit spread reaching 82bps, the lowest ever recorded. Meanwhile, Asian High Yield (HY) credit spreads are currently just below their historical average at 610bps, well above their historical lows of 322bps. Optimism towards China is growing, evidenced by a bull market in Chinese equities, which have surged over 20% since January lows. Additionally, UBS recently shifted to a positive outlook on the Chinese real estate sector, a significant component of the national economy. In a surprising move, Indonesia's central bank increased interest rates by 25bps, driven by concerns over currency volatility and the country's reliance on imported food and fuel. Governor Perry Warjiyo highlighted the necessity for an "anticipatory, forward-looking, and pre-emptive" policy stance. This hike, prompted by the delay in the Fed's normalization, signals a broader trend among EM central banks, which may shift from cutting rates to pausing or increasing them to manage external pressures.

Our view on fixed income (April)


For government bonds with maturities of less than 10 years, we hold a neutral stance. 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

Rate Cuts on Hold Until After US Elections? 


Source: Bloomberg

Market expectations are now leaning towards no Federal Reserve rate cuts ahead of the US elections, with projections for fewer than two cuts in 2024. Additionally, the timeline for the Fed’s monetary policy normalization has been pushed back, with forecasts suggesting the central bank might not reach a 4% terminal rate until at least summer 2026. This adjustment implies maintaining a restrictive monetary policy for over two more years. As a result, the 2-year US Treasury yield has risen back to 5% this week. The key question now is whether the Fed will delay rate cuts further, waiting for clearer signs of inflation aligning with its target, potentially at the expense of economic growth. This cautious approach could necessitate more aggressive measures when rate cuts eventually commence. 


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