Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks

Inflation Volatility Clouds Rate Cut Trajectory!

While no major central bank meetings took place last week, inflation surprises and shifting rate expectations fueled volatility across markets. In the U.S., Fed Chair Jerome Powell reiterated that the Fed is in no rush to cut rates, emphasizing the need for clear evidence of cooling inflation. However, January’s hotter-than-expected CPI print (3.1% YoY vs. 2.9% expected) forced markets to slash rate cut expectations, at one point pricing in just one 25bp cut by year-end. Later in the week, softer PPI inflation and weak retail sales provided relief, helping rate expectations recover to -42bps by year-end, with the first 25bp cut now fully priced for summer. The looming threat of tariffs on U.S. imports adds further uncertainty to the inflation outlook, making Fed policy decisions increasingly complex. In the Eurozone, Q4 GDP growth was revised up to +0.1% (vs. 0.0% prior), supported by resilient Southern European economies, while Germany and France remained in contraction. Optimism over a potential Ukraine resolution helped support sentiment, leading to a marginal pullback in ECB rate cut expectations to -78bps for 2025 (vs. -84bps last week). A 25bp cut in March remains fully priced, with additional moves anticipated in June and October. ECB Governing Council member Joachim Nagel stressed that a gradual approach is now more appropriate, as the ECB moves toward its neutral rate. In the UK, better-than-expected Q4 GDP growth (+0.2% vs. flat expected) did not alter market pricing for -58bps of rate cuts in 2025. The BoE remains stuck in a stagflation dilemma, with persistent wage growth and sticky services inflation limiting its ability to ease aggressively. In Switzerland, subdued inflation (-0.1% MoM, +0.4% YoY) led to a slight reduction in SNB rate cut expectations (-38bps vs. -47bps last week), as markets reassess the likelihood of multiple cuts in 2025. With rate uncertainty at its peak, central banks are being forced to balance inflation volatility against slowing economic growth, making policy clarity elusive in the months ahead.

Credit

Spreads Tighten Further as Tariff Fears Ease, Ceasefire Hopes Support European Credit

A potential Russia-Ukraine ceasefire could significantly impact European credit markets, particularly through lower energy prices and improved business confidence. A resumption of Russian gas imports would reduce electricity and production costs, benefiting European manufacturers and utilities. Additionally, Poland, Slovakia, and Romania—economies heavily impacted by the war—could experience a rebound in sentiment and investment. However, for U.S. and European credit markets, rate movements remain the dominant driver of performance. Credit spreads continue to tighten, supported by solid technicals and healthy corporate balance sheets. Despite concerns around tariffs, corporates have remained cautious on large M&A transactions, which has been credit-supportive. With absolute yield levels still attractive, any spread widening has consistently met strong investor demand, limiting the scope for a significant credit selloff in the absence of a recession. In the U.S. credit market, investment-grade (IG) spreads tightened 4bps to 80bps, driving a +0.6% gain in the Vanguard USD Corporate Bond ETF last week (+1.2% YTD). U.S. high-yield (HY) spreads narrowed 5bps to 262bps, marking a 30bps tightening in just six weeks. The iShares Broad USD High Yield Corporate Bond ETF added +0.5% for the week, bringing YTD performance to +1.9%. In Europe, credit markets outperformed as ceasefire optimism and a delayed U.S. tariff timeline (now set for April) supported sentiment. Euro IG spreads tightened by 3bps to 88bps, marking a 13bps tightening YTD. However, Bund yield increases slightly weighed on performance, with the iShares Core Euro IG Corporate Bond ETF down slightly. Euro HY spreads tightened 4bps to 292bps, with a 19bps tightening YTD, pushing the iShares Euro HY Corporate Bond ETF up +0.3% last week. High-beta credit segments continue to outperform, led by AT1 CoCos, with the WisdomTree AT1 CoCo ETF climbing +0.4% for the week (+2.1% YTD), reflecting strong earnings from European banks. European corporate hybrids were flat for the week but remain up +1.6% YTD. As the ECB’s rate-cut cycle progresses, investors may shift funds from money markets to corporate credit, supporting further spread tightening. However, geopolitical uncertainty remains a key risk, as negotiations over a potential Russia-Ukraine ceasefire are still evolving.

Rates

U.S. Treasuries Steady Amid Inflation Volatility, European Yields Edge Higher!

U.S. Treasury yields ended the week flat, but not without volatility. Softer-than-expected retail sales initially fueled optimism for more rate cuts, but a hotter CPI print (driven by rising auto insurance and used car prices) led to a midweek jump in yields. The 10-year Treasury yield briefly surged, before stabilizing at 4.50%, unchanged from the prior week. Markets are now pricing in -42bps of cuts by year-end, with at least one full 25bp cut expected in the second half of 2025. Meanwhile, the 3-year Treasury yield fell 4bps to 4.30%, reflecting expectations for Fed easing. The U.S. yield curve steepened, as ceasefire optimism overshadowed tariff concerns, stabilizing market sentiment. The iShares USD Treasuries ETF gained +0.2% last week, bringing YTD returns close to +1%. In Europe, rate expectations continue to reflect three 25bp ECB cuts in 2025, as markets anticipate a dovish stance to counteract the potential economic drag from new U.S. tariffs. However, slightly stronger Q4 GDP data in both the Eurozone and UK pushed yields higher. German Bund yields climbed, contributing to a -0.3% decline in the iShares Core EUR Govt Bond ETF, reversing part of the previous week’s gains (+0.7%). Investors are closely watching the German elections this Sunday, which could shape fiscal policy and investor sentiment for months ahead. UK Gilt yields also ticked higher, with the Vanguard U.K. Gilt ETF slipping -0.1% on the week, though it remains up +1.7% YTD. Meanwhile, Japanese government bonds continue to struggle, as the 10-year JGB yield hit 1.40%—its highest since 2011. The iShares Core JP Government Bond ETF lost -0.3% last week, bringing YTD losses to -1.3%, reflecting investor concerns over a potential 25bp BoJ rate hike in 2025. With rising uncertainty around inflation, tariffs, and central bank policy paths, rate markets remain volatile. Investors are weighing Fed cut expectations, ECB accommodation, and Japan’s tightening, as global bond markets navigate a shifting macroeconomic landscape.

Emerging market

Ukrainian Bonds Surge on Peace Talks, While Mexico Faces Political Uncertainty.
Emerging market (EM) bonds had a strong week, with Ukraine leading the rally following the Trump-Putin agreement to initiate negotiations to end the war. The potential for peace talks drove Ukrainian sovereign bonds higher, while neighboring countries, including Romania and Poland, saw gains in their government bonds. Improved geopolitical sentiment also supported broader EM debt, as the market priced in a reduced risk premium for Eastern European assets. On the other hand, Mexican bonds continued to trade wider, reflecting ongoing tensions with the Trump administration. At the Munich Security Conference, U.S. Vice President J.D. Vance referenced Romania’s annulment of elections as a threat to democracy, though this was largely viewed as an attempt to promote the American democratic model in Europe rather than a direct critique of Romania’s constitutional process. Overall, EM sovereign bonds outperformed: The iShares Emerging Market Sovereign Bonds ETF climbed +0.6% last week, benefiting from spread tightening and broader risk-on sentiment. EM corporate bonds also posted gains, with the iShares Emerging Market Corporate Bonds ETF rising +0.3%, driven by credit spread resilience and investor appetite for carry assets. In Asian high-yield debt, the iShares USD Asia High Yield Bond ETF gained +0.5%, reflecting stabilizing investor sentiment toward Chinese property bonds.


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

U.S. Real Long-Term Yields Hit Cycle Highs—Can Fiscal Reforms Bring Them Down?      

20250210_cow

Source: Bloomberg

Long-term real yields on U.S. Treasuries have climbed to their highest levels in this cycle, reflecting inflation concerns, record-high government debt, and fiscal uncertainty. With 10-year real yields nearing 2.5%, the new Trump administration is pushing for aggressive reforms to bring them down. 
-    Bessent’s 3-3-3 Plan aims to restore fiscal credibility through: 3% Deficit-to-GDP Target – A sharp reduction from 6%, slowing debt accumulation. 3% Real GDP Growth – Fueled by tax incentives, deregulation, and energy expansion. 3M Barrels/Day Increase in U.S. Oil Production – To lower energy costs and curb inflation.
-    DOGE (Decentralized Open Government Expenditure) is an ambitious initiative to track and automate U.S. government spending using blockchain technology—aiming to increase transparency, reduce fraud, and enforce spending caps through automated oversight.
Markets remain skeptical. If these policies restore fiscal discipline, they could drive long-term real yields lower, but execution risks remain high. The battle over U.S. borrowing costs is just beginning.

Disclaimer

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