Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks

The latest Federal Open Market Committee (FOMC) meeting presented an unexpected turn of events that caught financial markets by surprise. While expectations leaned towards a no-cut but hawkish stance from Chair Powell, he instead revealed plans to reduce the pace of quantitative tightening (QT) starting June 1st and indicated that a rate hike is "unlikely" to be the Fed's next move. This pivot reflects the Fed's commitment to the monetary normalization roadmap established at the end of last year, despite ongoing challenges with high inflation. The decision to lower the monthly QT cap from $60 billion to $25 billion is aimed at easing the upcoming pressure from a significant increase in US Treasury issuances, potentially seen as a move towards debt monetization given its alignment with the Treasury's increased issuance plans. In Europe, the scenario was more static; ECB futures implied that rates remained largely unchanged through the week, still anticipating the initial rate cut in June followed by two more within 2024. The ECB, guided by Chief Economist Philip Lane, continues to advocate for a cautious, data-driven approach to rate adjustments. Lane stresses the importance of flexibility in monetary policy against the backdrop of an uncertain economic environment, highlighting the risks associated with moving too swiftly or sluggishly. He points out that policy adjustments need to be carefully aligned with ongoing inflation dynamics, suggesting a potentially more calibrated approach if inflation remains stubborn. Globally, monetary policies are exhibiting cautious recalibrations. Following Indonesia’s recent rate hike of 25bps due to currency volatility concerns, the Norges Bank has opted to keep its rates steady, signaling potential delays to planned rate cuts later in the year after an unexpected depreciation of the krone. This situation illustrates a broader dilemma: while some countries feel pressured to loosen monetary policy to support their economies, doing so could weaken their currencies and make imports more expensive. This complex interplay underscores the challenges central banks face as they navigate a landscape shaped by both domestic needs and global monetary conditions, especially under the continuing influence of the US's restrictive policy stance.


In the U.S., Investment Grade (IG) credit spreads narrowed to 86 basis points by week's end, the tightest since November 2021, reflecting growing investor confidence in a resilient U.S. economy. This optimism is bolstered by increasingly bullish outlooks from corporate CEOs. Despite this, the first quarter earnings season has revealed some softness in consumer demand, with companies like Starbucks, Yum, and McDonald's issuing warnings. While these signals may raise concerns for equity markets regarding earnings growth, from a bondholder's perspective, the fundamentals remain robust. The Vanguard USD Corporate Bond ETF saw a 2.3% decline in April, even as credit spreads tightened over the month. Year-to-date, IG corporate bonds have fallen by 1.5%, still outperforming U.S. Treasuries which are down 2% thanks to a 15 basis point spread tightening and higher carry. In the High Yield (HY) space, the combination of higher carry and lower duration risk has led to a relatively strong performance within fixed income, with the iShares Broad USD High Yield Corporate Bond ETF gaining 2% for the year, despite a more than 1% pullback in April. U.S. high yield credit spreads have shown remarkable stability, closing the week at their lowest since Q1 2022. In Europe, first quarter corporate earnings have generally been robust, supporting overall market strength despite sectoral weaknesses among lower-quality companies. The financial sector received a boost last week from M&A activity, highlighted by BBVA's bid for Sabadell in Spain. The iShares Core EUR Corporate Bond ETF recorded a 1% loss in April, largely due to rising European interest rates, though European IG credit spreads have remained stable. Nonetheless, year-to-date, the ETF has remaining flat and outperforming similar U.S. indices. Recovery in the European high yield sector continues gradually from recent setbacks in CCC-rated bonds like Altice, Ardagh, and Intrum. Moreover, volatility hit Kloeckner Pentaplast’s bonds (CCC-rated) due to weaker-than-expected earnings. Despite these idiosyncratic risks, the iShares EUR High Yield Corporate Bond ETF has risen by 0.5% in 2024 after a minor April loss of 0.2%. European banking's junior subordinated debts concluded the week strongly, buoyed by bank M&A activity in Europe. The WisdomTree AT1 CoCo Bond ETF is up 2.7% for the year, despite a 0.5% decrease in April. In the UK, the market's strong appetite for high-yield debt was underscored last week by Asda's record-breaking £2.25 billion sterling high-yield bond refinancing, marking the largest such issuance ever in the region. This confirms the sustained demand for higher-yielding investments amidst current market conditions.


U.S. Treasuries significantly benefited from the Federal Reserve's dovish adjustments, as reflected in the substantial easing of yields following the latest FOMC meeting. The 2-year U.S. Treasury yield saw its largest two-day decline of 2024, dropping over 20 basis points to close the week at 4.8%. The longer end of the curve also experienced a downward adjustment, with the 10-year yield decreasing by 15 basis points to 4.5%. This shift was largely catalyzed by the Fed's decision to reduce the pace of Quantitative Tightening (QT), with the QT cap reduction to $25 billion from a potential $30 billion. This strategy will enable the Fed to retain approximately $300 billion in coupon-bearing Treasuries, which is about 25% more than would have been held under the higher cap, providing substantial support to the long end of the yield curve. Additionally, U.S. interest rate volatility has seen a marked decrease, dropping from 120 to 95 in the last two weeks, although it remains in a high volatility regime compared to the average of 119 since 2022. Despite these positive developments, April was challenging for U.S. Treasuries, as the iShares U.S. Treasury Bond ETF posted its largest monthly decline since September 2022, falling by 2.7%. However, the recent rally helped curb year-to-date losses to -2%. The long-end of the curve, tracked by the iShares 20+ Year Treasury Bond ETF (TLT), has seen a year-to-date decline of 8%, reflecting ongoing caution among investors. In Europe, government bond movements were pronounced but varied. The 10-year German yield fell by 8 bps to 2.5%, while the 2-year yield decreased by 6 bps to 2.92%. The spread between Italian and German bonds has narrowed close to its 2024 low, reflecting increased confidence in peripheral European countries amid signs of economic recovery. Italy's latest unemployment figures were notably positive, dropping to 7.2%, the lowest since the 2008 financial crisis. However, the iShares Core EUR Government Bond ETF closed April down by 1.4%, extending its year-to-date loss to 1.6%. In the UK, bonds tracked closely with U.S. trends, ending April down by 2.9% and down 3.6% for the year. Meanwhile, in Japan, the 10-year yield reached its yearly high of 0.9%, not participating in the early May rally that boosted the broader global government bond market.

Emerging market

April proved challenging for Emerging Market (EM) debts, influenced by rising US interest rates and a stronger US dollar. The Bloomberg EM Corporate Bond Index declined by 1.3%, and the Bloomberg EM Sovereign Bonds Index saw a 2% drop. Despite a turbulent month, EM FX managed a partial recovery, improving from a 5% loss mid-April to less than a 3% decline by month's end. However, EM local currency debts fell by 1.4% over the month, cumulating a 1.8% year-to-date loss. On a brighter note, year-to-date performance for EM debts has been positive, with EM corporate bonds up 1.7% and EM sovereign bonds gaining 0.7%. The market outlook remains optimistic, particularly in Brazil where Moody’s has upgraded the country's outlook to positive. This adjustment reflects improved GDP growth expectations and fiscal progress, suggesting potential stabilization of the debt burden. Additionally, the Brazilian Central Bank is expected to cut interest rates by another 50bps at the upcoming COPOM meeting in May, supported by April's lower-than-expected IPCA-15 inflation rate of 0.21% versus the 0.29% forecast. Brazilian food giant BRF saw its long-term issuer default rating upgraded by Fitch to BB+ from BB, with a stable outlook. This upgrade acknowledges anticipated improvements in BRF's credit metrics in 2024, aligning with a 'BB+' rating due to enhanced operating cash flow generation and effective debt reduction strategies over recent years. In Mexico, Claudia Sheinbaum of the Morena party remains the frontrunner in the presidential elections, holding a significant lead with 58% of the vote according to recent polls. She has committed to continuing the economic policies of the current administration, suggesting a likely continuation of the status quo should she win. Meanwhile, Cemex received a credit upgrade from Fitch to BBB- from BB+, with a stable outlook, reflecting the company's strengthened credit profile through consistent improvement in cash flow and a robust liquidity position. In other positive developments, Fitch raised the credit rating outlooks for Egypt and Nigeria to positive from stable, marking an optimistic shift in their economic projections. outlook was raised to positive from stable by Fitch. 

Our view on fixed income (May)


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

'Higher for Longer' — The Fed Fund Future Market Takes Heed!


Source: Bloomberg

The market has notably adjusted its expectations for the Federal Reserve's monetary policy over the coming years. Initially, an aggressive trajectory toward a terminal rate of around 3% was projected at the start of the year, indicating a return to a Neutral rate adjusted for inflation. However, current forecasts now suggest a more cautious normalization, with a significantly higher terminal rate of 4%. Intriguingly, the market anticipates further tightening by mid-2026, which some analysts believe could echo the inflation resurgence patterns of the 1970s. The Neutral rate (R*), long considered to be around 0.5%, is now hotly debated and estimated to be between 1.5% and 2.0% in the United States. The Fed Funds Futures market appears to have already factored in the impacts of enduring fiscal deficits, improved productivity, and deglobalization trends. How will these elements continue to influence Fed policy amid shifting global economic dynamics?


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