Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks

In the US, the discourse around monetary policy remains cautiously optimistic but measured. Mary Daly, President of the Federal Reserve Bank of San Francisco, has noted that while recent inflation data suggests that monetary policy is effectively slowing economic activity, it's still too soon to consider lowering borrowing costs. This sentiment is echoed by Raphael Bostic, President of the Federal Reserve Bank of Atlanta, who sees the potential for a rate cut later in the year if inflation continues to decline. He underscores the need for continued vigilance, as the balance between curbing inflation and supporting employment is delicate. Bill Dudley, former New York Fed President, adds a note of caution about the long-term implications of the US's growing budget deficits. He warns that although immediate market disruptions are unlikely thanks to the Fed's management strategies, there remains a risk of future investor backlash reminiscent of the bond vigilantes in the 1990s. Dudley's comments reflect broader concerns about fiscal sustainability and its impact on monetary policy. Across the Atlantic, the tone at the European Central Bank is also one of cautious flexibility. Isabel Schnabel stresses that the ECB remains committed to a data-dependent approach, prepared to adjust rates in response to new economic information rather than committing to a predetermined path. This approach is crucial as the ECB navigates through what she describes as a bumpy disinflation process, particularly within the services sector where price pressures are still pronounced. Fabio Panetta and François Villeroy de Galhau, both influential voices within the ECB, emphasize the need for readiness against a backdrop of political and economic uncertainties. Panetta highlights the importance of preparing for extreme scenarios that could deviate from baseline economic projections, while Villeroy de Galhau advises a steady hand in response to transient price fluctuations, reassuring that the ECB's confidence in its forecasts supports a less reactive monetary policy stance. As the ECB has initiated rate cuts, expectations are building for further easing, potentially in the coming months, with market odds favoring another reduction by year-end. This careful and responsive approach characterizes the current global central banking strategy, balancing immediate economic indicators with longer-term fiscal and monetary stability goals.


In the US, the credit market concluded the second quarter on a buoyant note, buoyed by strong June performances across both investment grade (IG) and high yield (HY) segments. The Vanguard USD Corporate Bond ETF enjoyed a robust June, climbing by 1.1% to finish the quarter up by 0.4%. However, the IG market experienced some spread widening, with spreads increasing by 6 bps to 94 bps during the month. The high yield sector also fared well, with the iShares Broad USD High Yield Corporate Bond ETF gaining 0.4% in June, culminating in a 0.9% rise for the quarter. Despite remaining stable in June at 310 bps, HY spreads overall widened slightly by 10 bps over the quarter. Notably, credit market volatility has risen, with the IG Credit Volatility Index reaching its peak for the year and the CDX HY 1-month volatility index surging to 137 from 118 at the end of March. In Europe, the iShares Core Euro IG Corporate bond ETF recorded a 0.7% increase in June, although it was insufficient to secure a positive quarterly result, ending slightly down by 0.1%. June was particularly challenging for IG credit spreads, which widened by 12 bps to 120 bps driven by the uncertainties of French elections. An interesting trend noted by JPMorgan highlights a significant negative correlation between rates and credit spreads, the most pronounced in a year, with the correlation between sovereign yields and Euro investment grade spreads deepening to -52%, the lowest since early 2023. The European high yield sector saw modest gains, with the iShares Euro HY Corporate bond ETF inching up by 0.2% in June despite a 30 bps spread widening, and closed the quarter with a 0.7% increase. However, it experienced the largest outflows since March 2020 during the last week of June. Performance in specialized credit segments like AT1 and corporate hybrids was strong, with both the WisdomTree AT1 CoCo Bond ETF and the Invesco Euro Corporate Hybrid ETF climbing by 0.9%. Nevertheless, the AT1 segment felt the brunt of volatility from the French elections, remaining flat in June compared to gains of +0.9% in corporate hybrids.


US Treasury bonds concluded the second quarter of 2024 on a modestly positive note, eking out a 0.1% gain for the Bloomberg US Treasury Index, despite facing ongoing challenges. The yield curve, illustrating the difference between 2-year and 10-year yields, reached a yearly low of -49 basis points (bps) earlier last week. However, the curve notably steepened due to the US presidential election debate, closing the quarter at -35 bps, an improvement from -41 bps at the end of March. The 10-year US Treasury yield rose by 20 bps over the quarter to finish at 4.40%, primarily driven by an increase in US real yields. Meanwhile, the 2-year yield climbed 13 bps to end at 4.75%. On the brighter side, intermediate maturities showed strength, with the iShares 3-7 Year Treasury Bond ETF gaining 0.5% for the quarter and 0.9% in June. However, longer maturities faced tougher conditions; despite a strong June performance of 1.9%, the iShares 10-20 Year Treasury Bond ETF recorded a quarterly loss of 1.2%. Inflation-linked securities emerged as the standout performers, with the iShares USD TIPS ETF gaining nearly 1% over the quarter, benefiting from inflation adjustments. European rates, however, were less fortunate, pressured by the continent's economic recovery and tensions surrounding European elections coupled with the ECB's initial rate cut. The 10-year German yield rose by 20 bps to 2.5%, and the 10-year French yield surged over 50 bps to 3.3%. Consequently, European bond ETFs struggled; the iShares EUR 3-7 Year Government Bond ETF ended the quarter down 0.6%, despite a 0.4% gain in June. The iShares EUR 10-15 Year Government Bond ETF was flat in June but posted a 2.4% loss for the quarter. Looking ahead to the third quarter of 2024, the ongoing French legislative elections and the anticipated ECB rate cut in September will be key factors influencing market performance, potentially fostering a more favorable environment for European bonds.

Emerging market

Emerging market bonds in US dollar denominations concluded the quarter on an upbeat note, largely supported by solid US Treasury performances and tighter credit spreads. Specifically, the iShares Emerging Market Sovereign Bonds ETF advanced by 0.7% over the quarter, adding 0.6% in June alone, with credit spreads holding steady at 326bps. Meanwhile, the iShares Emerging Market Corporate Bonds ETF rose by 1.2% for the quarter, thanks to credit spreads tightening by 15bps to 214bps. However, the local currency scene was less rosy. The VanEck J.P. Morgan EM Local Currency Bond ETF dipped by 1.7% throughout the quarter, largely due to a strengthening US dollar, which appreciated by 1.7%, and political turbulence from presidential elections, particularly in Mexico. Latin American currencies faced significant challenges; the Mexican peso dropped by 6.5%, the Brazilian real decreased by 4%, and the Colombian peso fell by 5%, while the South African rand managed to climb by 4%. This week, Mexico's central bank, Banxico, maintained its policy rate at 11.0% but hinted at a possible rate cut in August through a dovish statement. This suggests that further easing might be on the horizon, depending on the inflation outlook, though it remains unclear whether this would initiate a cutting cycle or stand as a singular adjustment. Significant developments also unfolded with the phased inclusion of Indian local government bonds into the J.P. Morgan GBI-EM Global Series. This strategic inclusion, expanding over ten months, is set to achieve a 10% weight by March 2025, enhancing India's footprint in the global bond market. Lastly, Moody’s Ratings adjusted Colombia's outlook from stable to negative while maintaining a Baa2 rating. This change reflects mounting concerns over slow economic growth and escalating borrowing costs, which strain government finances and risk deteriorating the nation’s credit profile. Earlier in the year, S&P had made a similar revision. In response to these economic pressures, Colombia's government has announced a significant $5 billion cut in spending to manage a revenue shortfall and mitigate market anxieties, highlighting the ongoing fiscal challenges.

Our view on fixed income (July)


For government bonds with maturities of less than 10 years, we turn positive. 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

US Treasury Yields Resilient Amid Mixed Economic Signals! 


Source: Bloomberg

As the second quarter of 2024 unfolded, a noticeable normalization of the US economy became evident, marked by a significant downturn in the US Citi Economic Index from 33 to -29, reaching its lowest level in nearly two years. Despite these economic headwinds, the 10-year US Treasury yields closed the quarter slightly higher at 4.30%, a 10-basis point increase. This apparent contradiction between economic cooling and rising yields can be largely attributed to substantial US Treasury issuances, necessary to fund the expansive US fiscal deficit. Furthermore, persistent inflationary pressures have prompted the central bank to delay the anticipated rate cut from July to November 2024, adjusting expectations amid changing economic conditions. As we approach a typically low-liquidity summer period, any shifts in interest rates could be magnified. Additionally, with the US presidential election on the horizon, market sentiments could be further influenced by electoral outcomes. The looming question is: Which will have a greater impact on third-quarter rates—the slowdown in the US economy, the ongoing inflationary and supply pressures, or the unfolding political landscape?


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