Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks

This week, Fed’s Dallas Logan noted that the recent surge in long-term Treasury yields might reduce the necessity for the U.S. central bank to raise its benchmark interest rate further. She highlighted that "higher term premiums result in higher term interest rates for the same fed funds rate setting." On the other hand, Fed governor Michelle Bowman maintained her stance that interest rates will likely need to increase to combat inflation. She emphasized that "elevated energy prices could reverse some of the progress we've seen in taming inflation recently." While Fed members hold varying views, the prevailing sentiment leans toward a cautious approach to rate hikes. This is especially pertinent given the latest CPI and PPI reports, both of which revealed another round of surprising upside inflationary pressures. While the market had significantly increased the probability (>50%) of a Fed rate hike by year-end following the CPI release, the chances have now receded to just 33%, a level lower than a week ago (45% chance). In Europe, ECB members were active with ECB President Christine Lagarde reaffirming that the central bank is closely monitoring the impact of previous rate increases and is prepared to raise interest rates again if circumstances require. Notably, there was an increased emphasis on the potential inflationary impact of geopolitical risks, particularly concerning the Israeli-Palestinian conflict, within their speeches. ECB’s Simkus expressed his concern about these geopolitical risks affecting inflation. As the week concluded, the market continues to anticipate no ECB rate hike (with a probability of less than 5%) by year-end. In the UK, BoE Governor Bailey emphasized that upcoming meetings will maintain a tight stance on monetary policy, despite advances in addressing inflation. The UK's economic outlook is characterized as subdued, and monetary policy is operating in a restrictive manner. Bailey underscored the importance of assessing the impact of rate hikes on the economy, particularly in the mortgage market.


In the U.S., credit spreads tightened during the week, defying rising geopolitical tensions. The average spread of the Bloomberg U.S. Investment Grade (IG) corporate bond index closed at 123 bps, a decrease of 2 bps, while the CDX IG 5-year index remained unchanged at 75 bps. The week favored U.S. IG corporate bonds, posting a performance gain of +1% due to lower U.S. interest rates. In the high-yield sector, the trend was similar, with cash markets outperforming the synthetic ones. The average spread of the Bloomberg U.S. High Yield corporate index tightened by 10 bps to 410 bps, while the CDX HY 5-year index remained almost unchanged at 494 bps. The U.S. high yield index recorded a +0.5% increase for the week. JPM's Q3 2023 results provided reassurance to the market, with 5-year CDS tightening by 5 bps. In Europe, all credit indices, both cash and synthetic, tightened. The Itraxx Europe Main index closed the week 1 bp lower at 84 bps, while the Itraxx Xover index decreased by 4 bps to reach 450 bps. Both the Bloomberg EUR IG corporate index and the EUR HY corporate index showed positive performance, up by +0.5% for the week. European subordinated debt also had a strong week, with the ICE BofA Contingent Capital Index posting a gain of more than 1% over the week.


Is it finally time for the correlation between rates and equities to turn negative? The enduring positive relationship between the two could be under threat due to the rise in geopolitical tensions. US rates demonstrated strength this week, with the Bloomberg US Treasury index recording a +0.75% gain over the week, largely propelled by real rates. Indeed, the 10-year US real yield fell from 2.485 to 2.28 in just one week, while the 10-year US breakeven yield saw a minor uptick from 2.31 to 2.35%. This week saw a pronounced flattening of the US nominal yield curve (2s10s), shifting from -28 to -42. This signifies concerns about macroeconomic stability, likely influenced by the ongoing Israel-Palestine conflict and robust inflation data (U. of Mich. 5-10 Yr Inflation rose to 3% vs. an expected 2.85%). Conversely, the US real yield curve (2s10s) exhibited a slight steepening, moving from -90 to -84 bps, indicating that there is room to navigate in case of stagflation. After reaching its highest level this cycle at 4.8% last week, the 10-year US Treasury yield closed the week at 4.64%. Worth noting is the 30-year US Treasury yield, which decreased by 20bps, accompanied by an auction showing a significant tail—the largest since November 2021. In Europe, it was also a favorable week for rates. The 10-year German yield dropped from 2.88% to 2.73%, driven primarily by real rates. In contrast, the front-end remained stable, with the 2-year German yield ending the week at 3.13%. Notably, a flight to quality trade became evident in the spreads over bund. For the first time since the peak of the COVID pandemic, the difference between the 10-year France and Germany yields rose to 65 bps, before a slight retraction to 63 bps. Interestingly, peripheral spreads (Italy, Spain) did not experience as much turbulence as France.

Emerging market

In the realm of emerging markets, US Dollar-denominated corporate bonds have displayed remarkable resilience, with average spreads (OAS) dipping below 300 bps, marking the first instance since June 2021. EM sovereign bond spreads also tightened, partially attributed to a few index modifications by the provider. Both indices posted gains for the week, with EM sovereign bonds surging by more than +1.2%, while EM corporate bonds witnessed an increase of +0.5%. In a noteworthy development, China is contemplating increasing its 2023 budget deficit by at least $137 billion as part of a new stimulus strategy aimed at achieving annual growth targets. This shift underscores a significant change in Beijing's approach and reflects concerns about the country's economic direction. There's increasing momentum behind calls to relax deficit limits in the face of ongoing economic challenges. Concurrently, this is a pivotal moment for Country Garden. The grace period is about to end for a dollar-bond coupon, offering the strongest indication yet that a maiden default and restructuring of offshore debt may occur. In Mexico, Pemex CEO Romero reported that the oil company's debt had been reduced to $106.3 billion as of September and efforts to further reduce the debt will continue through the end of the year. Pemex's debt-to-GDP ratio is expected to decrease to 6.1% this year from 8.6% at the end of the previous administration. Lastly, amidst the ongoing Israel-Palestine conflict, Israel's local currency yields have decreased to 3.9% from 4.5%.

Our view on fixed income (October)


We recommend gradually extending duration, as there is an attractive asymmetry in rates, supported by expected moderation in growth and inflation. High real rates and elevated long-term inflation expectations contribute to this favorable outlook. However, we exercise caution given the ongoing reduction of the Fed's balance sheet, which affects liquidity and rate dynamics, and the anticipation of higher supply that could trigger ST shock.

Investment Grade

We favor from 0 to 10 years segments due to the steepness of the credit spread curve which fully offset the inverted U.S. Treasury yield curve. Absolute yields are still offering attractive long term entry point. Focus on high quality corporate bonds that have proven their robustness even if money market funds compete the entire credit spectrum.

High Yield


High yield bonds could come under pressure in this very 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 current valuation of U.S. high yield spreads implies modest default rates and the absence of inflation slippage, or a near-term recession.


In Emerging Market debt, we maintain a vigilant stance due to valuation and potential risk considerations. Higher oil prices and a strong US dollar pose challenges for oil-importing EM nations, especially Asian countries, while some Latin American countries may benefit.

The Chart of the week

Emerging Market Corporate Bonds Displaying Remarkable Resilience!

202310_em corp OAS

Source: Bloomberg

The average spread of EM corporate bonds has dipped below 300 bps for the first time since June 2021. Despite increasing geopolitical tensions, the unresolved situation in China's real estate sector, elevated US real rates, and a stronger US dollar, EM corporate fundamentals are working in their favor, aided by a relatively subdued primary market. In 2023, US dollar-denominated EM corporate bonds stand out as one of the few fixed income segments delivering a positive return thus far. To put it in perspective, US Treasuries are down by 2%.


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