Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks

Central banks maintained a cautious tone last week, with both the Federal Reserve and the European Central Bank facing increased policy complexity amid renewed tariff threats and persistent fiscal uncertainty. In the U.S., Fed officials struck a delicate balance: while acknowledging that rate cuts remain a possibility later this year, they also flagged rising inflation risks and growing doubts over fiscal discipline. Governor Waller noted that modest tariffs—if capped and implemented soon—might not derail the easing narrative, but he firmly pushed back on the idea of monetary policy cushioning government deficits. Other officials sounded more guarded. St. Louis Fed President Musalem warned that near-term inflation expectations are climbing, posing a risk of spillover into longer-term expectations. He sees a low probability of interest rates returning to pre-pandemic levels in the next decade. Meanwhile, Presidents Daly and Hammack emphasized patience, citing the need to assess incoming data and trade-related developments. Market expectations adjusted accordingly, with less than 50bps of Fed cuts now priced in by year-end—down from 100bps at the end of April—as rising real yields and term premium point to mounting structural concerns. In Europe, ECB officials cautiously supported a potential rate cut at the June 5 meeting. Inflation continues to trend lower, but policymakers remain wary of trade-induced supply shocks. Klaas Knot stressed the need for updated forecasts before making any decision, while Pierre Wunsch endorsed market pricing for a 1.75% deposit rate by year-end, describing it as moderately accommodative. ECB Vice President Luis de Guindos highlighted declining energy prices and a stronger euro as factors helping inflation converge toward target, though he also warned that downside risks to growth are increasingly materializing. The June projections are expected to reflect this softening outlook. While an additional cut in June is largely anticipated, the path beyond the summer remains uncertain. Both the Fed and ECB are clearly in wait-and-see mode, navigating a challenging environment shaped by politics, external shocks, and a fragile inflation-growth tradeoff.

Credit

Credit markets lost ground last week as renewed concerns around the U.S. fiscal outlook and rising Treasury yields pressured spreads, reversing some of the prior week’s gains. Despite the soft performance, investor flows were encouraging across both sides of the Atlantic. U.S. investment-grade credit saw its first meaningful inflow in over two months, marking the strongest weekly pickup since early March, while Euro IG also posted its best inflow since September. Demand for high yield also accelerated in both regions, suggesting that investors are using market weakness as an opportunity to re-engage. Notably, Euro money market funds saw a fourth outflow in five weeks, reinforcing the relative appeal of credit. The macro backdrop remains supportive for corporates: companies are maintaining balance sheet discipline while fiscal burdens continue to grow at the sovereign level. In the U.S., the House passed a sweeping tax reform bill that could significantly benefit capital-intensive sectors such as defense, energy, and utilities, though the final text remains subject to political negotiation. Meanwhile, several major U.S. pharmaceutical firms have announced investment plans in domestic manufacturing, likely positioning for upcoming tariff shifts. In Europe, credit sentiment remains firm, supported by expectations of two to three more ECB rate cuts and attractive hedged returns versus JGBs in key credit segments. Reverse Yankee issuance has picked up sharply, driven by favorable euro funding costs, and primary market activity in EU high yield remains robust, with supply at a two-year high. Still, spreads widened modestly across the board. U.S. IG ended the week unchanged at 93bps, though the Vanguard USD Corporate Bond ETF slipped -0.6% (YTD +0.9%) amid duration pressure. Euro IG widened 3bps to 101bps, but the iShares Euro IG ETF gained +0.2% (YTD +1.1%) thanks to rangebound Bund yields. U.S. HY underperformed, widening 22bps to 340bps and losing -0.6% on the week (YTD +2.0%), while Euro HY widened 12bps to 342bps, with a -0.4% weekly return (YTD +1.9%). High-beta names also pulled back, with euro hybrids down -0.2% (YTD +1.1%) and AT1s retreating -0.7% (YTD +1.7%). In light of rising rate volatility and fiscal risk, a defensive, up-in-quality approach continues to look prudent. 

Rates

Rate markets were once again unsettled last week, with long-dated U.S. Treasuries underperforming sharply. The iShares 10–20 Year Treasury Bond ETF dropped -1.38%, while shorter maturities held up better—the 3–7 Year ETF ended slightly positive at +0.10%. Across the curve, the move reflected growing concerns about the U.S. fiscal trajectory, as debates over deficit-financed tax cuts and government spending continued to weigh on investor sentiment. A weak 20-year Treasury auction mid-week further exacerbated the selloff, driving yields to multi-month highs and pushing the 30-year above 5%. This contributed to a bear steepening of the curve, with the long end repricing to reflect increased supply risks and a renewed need for term premium. Interestingly, this came despite softer-than-expected inflation data in the U.S., which would normally provide support for bonds. However, central bank communication remained cautious: several Fed officials suggested rate cuts are not imminent, citing persistent macro uncertainty and the need for further evidence of disinflation. Meanwhile, inflation-linked bonds and broad Treasury indices were also down on the week, suggesting limited appetite for duration risk in current conditions. Globally, bond markets were impacted by mixed signals—commodity prices were broadly stable, but new trade tensions toward the end of the week introduced a more defensive tone. Overall, the market narrative has clearly shifted: even with disinflation in play, the long end is reacting more to fiscal and supply dynamics than to near-term monetary policy.

Emerging market

Emerging market debt posted mixed results last week, with local currency bonds strongly outperforming their hard currency counterparts. The VanEck EM Local Currency Bond ETF rallied +1.44% on the week, driven by broad EM FX strength and continued appetite for yield in a context of softer U.S. dollar performance. In contrast, USD-denominated sovereigns and corporates faced mild pressure, down -0.57% and -0.09% respectively, as rising U.S. long-end rates weighed on duration-sensitive segments. Asia high yield lagged again, with the iShares USD Asia HY ETF down -0.45%, still under the cloud of Chinese property sector risks and renewed tariff headlines. That said, expectations of targeted stimulus from Chinese policymakers helped contain the downside. Across regions, LatAm currencies and bonds benefited from positive carry and a supportive inflation backdrop, while EMEA performance was more dispersed, with some political noise resurfacing. On the macro side, inflation remains broadly contained across most EMs, supporting a cautious but ongoing easing cycle in select markets. Technically, the market absorbed the volatility well—spreads widened only marginally, and fund flows showed a stabilizing trend. The key takeaway this week is that local currency debt continues to offer compelling diversification and carry, particularly in an environment where global monetary policy is in flux and duration remains vulnerable.


Our view on fixed income 

Rates
NEUTRAL

We are neutral on government bonds with maturities of less than 10 years. This stance is supported by elevated real yields, an anticipated peak in central bank tightening, a shift toward disinflation, attractive relative value compared to equities, and improving correlations. Conversely, we hold a negative view on bonds with maturities exceeding 10 years. A flat yield curve and low term premiums reduce their attractiveness, particularly in the context of ongoing interest rate volatility and potential fiscal pressures.

 

Investment Grade
NEUTRAL
We are neutral on Investment Grade corporate bonds. The sharp tightening in credit spreads, reaching lowest level since 2021, has considerably reduced the margin for safety in credit. Corporate 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 while the credit market's overall health is supported by robust demand and strategic maturity management
High Yield
NEUTRAL

We are neutral on high-yield (HY) bonds, favoring short-dated HY while negative on intermediate and long maturities due to unattractive valuations. U.S. HY spreads have tightened, signaling low default expectations and economic stability. While short-term HY bonds offer selective opportunities, overall valuations appear stretched, particularly if volatility increases. We see more value in subordinated debt than HY bonds.

 
Emerging Markets
NEUTRAL
We have upgraded Emerging Market debt to neutral, driven by attractive absolute yields and solid fundamentals. The primary market remains healthy, and we favor short-dated EM bonds with yields above 6.5%. However, risks persist: valuations are stretched, Trump’s potential tariffs could pressure EM economies, and idiosyncratic risks remain, notably in Brazil and India. Given this backdrop, we stay selective, favoring short-duration opportunities while cautious on broader EM debt.

The Chart of the week

Fed Rate Cut Expectations Collapse Amid Tariff and Fiscal Jitters!

 

20250526_cowSource: Bloomberg

One of the most significant shifts in global fixed income this week came through rate expectations. Futures markets now price in less than two 25bp cuts from the Federal Reserve by the end of 2025—a steep drop from the 100bp of easing expected at the end of April. This dramatic repricing reflects the market’s reassessment of the inflation and fiscal risk landscape. Several Fed officials expressed concern over rising short-term inflation expectations, the impact of potential tariffs, and the long-term consequences of fiscal expansion. Elevated term premiums and a steepening curve suggest that the market is beginning to doubt whether the Fed can ease policy meaningfully without losing credibility on inflation. For fixed income investors, the implications are twofold: first, duration exposure becomes more volatile as long-end yields remain under upward pressure. Second, the repricing spills over into credit and EM markets, tightening financial conditions globally. As the macro environment pivots from a disinflation-driven easing narrative to one dominated by fiscal risk and trade shocks, the trajectory of rate cuts is no longer a given—and markets are adjusting fast.

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