Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks
Federal Reserve officials emphasize the necessity of maintaining elevated interest rates to combat persistent inflation. Fed Governor Bowman expects inflation to remain high and suggests that the Fed must be prepared to adjust rates if inflation does not decrease as expected. Other officials, including Loretta Mester and Barkin, also advocate for keeping borrowing costs high to ensure inflation returns to the Fed's 2% target. Meanwhile, Fed Chair Jerome Powell and Vice Chair Philip Jefferson have reiterated the importance of patience, suggesting that rates should stay steady until more definitive signs of declining inflation emerge. The market anticipates the first rate cut in November, with a high probability of seeing only one rate cut in 2024. Isabel Schnabel of the ECB advises against consecutive rate cuts in June and July, highlighting the risks of premature easing as euro-zone inflation nears the 2% target. This stance subtly hints at a desire to maintain policy alignment with the Fed to prevent excessive weakening of the euro. Vice President Luis de Guindos notes a slowdown in wage growth to about 4%, citing persistent economic uncertainties which compel the ECB to remain cautious without committing to a fixed path for future rate cuts. Despite these uncertainties, the market expects between 2 and 3 rate cuts, starting in June and potentially another in September. In the UK, the timing of the first rate cut remains unclear. While the market still anticipates a rate cut in August, there's a 60% chance of a cut as early as June. Bank of England's chief economist, Huw Pill, suggests that reducing interest rates over the summer is not unreasonable if inflation continues to decline. Despite a slight rise in unemployment, the UK job market remains tight, and robust wage growth prompts Pill to urge caution, emphasizing the importance of forthcoming jobs and inflation data. Finally, the Bank of Japan cut its bond-buying in a regular operation as a response to the yen's weakness—its first bond-purchase amount cut since December. This reduction is seen as a strategy to combat yen depreciation without resorting to interest rate hikes. The market expects another rate hike in September and one more in Q4 2024, reflecting ongoing adjustments to Japan's monetary policy in response to currency and economic pressures.


In recent weeks, the American credit market has been more sensitive to interest rate movements than to changes in credit spreads. This trend continued last week, as evidenced by the performance of the Vanguard USD Corporate Bond ETF and the iShares Broad USD High Yield Corporate Bond ETF, which registered gains of 0.8% and 0.5% respectively, aligning closely with US rate adjustments when factoring in duration. Credit spreads have held steady, with US Investment Grade at 87 basis points and High Yield at approximately 300 basis points. Remarkably, volatility in US IG credit spreads has reached its lowest level ever, and US High Yield spreads are also experiencing their least volatility since 2021. The primary market in the US was notably active last week, with significant demand for longer-term issues, which saw nearly a 4x weekly average oversubscription rate at the long end—significantly higher than other parts of the curve. Notably, the proportion of US high yield bonds trading with spreads below 200 basis points has hit an all-time high (close to 50%). In Europe, investment grade credit spreads remained constant at 110 basis points, yet the primary market was exceptionally busy, marking its fifth busiest week ever with more than €30 billion issued across over 30 deals. Despite this influx, demand stayed robust, with new issue premiums remaining very tight (less than 10 basis points) and book coverage maintaining an average of 3.2 times. European high yield spreads tightened slightly to 343 basis points. Both the iShares Core Euro Corporate Bond ETF and the iShares Euro High Yield Corporate Bond ETF saw modest gains of 0.1% and 0.2%, respectively. The standout performer in European fixed income was the contingent convertible bonds segment, with the WisdomTree AT1 CoCo Bond ETF gaining 0.5%.


US Treasuries showed resilience last week, with the iShares USD Treasuries ETF gaining 0.6%. After three consecutive months of CPI surprises, the latest inflation data did not exceed expectations, breaking the trend and bolstering the performance of US Treasuries. This outcome has helped stabilize the investment landscape in fixed income, despite ongoing challenges to fully normalize monetary policy amid persistent inflation. The 10-year US Treasury yield finished the week down at 4.41%, dropping 30 basis points from its peak in late April. Notably, despite recent selling pressures, yields have remained below the highs seen in October of the current cycle. However, the pressure on Treasuries may increase, especially from foreign investors; China, for instance, offloaded a record $53.3 billion in Treasury and US agency bonds in the first quarter. Additionally, Japan might sell US Treasuries to support the Yen. In Europe, the week was quieter, with the iShares Core EUR Govt bond ETF registering a modest gain of 0.1%. The 10-year German yield remained steady at 2.51%, consistent with levels seen four months ago. As the ECB is set to begin its normalization process in less than a month, it will be intriguing to see how the market reacts, since the last two to four months before the first rate cut generally benefit government bonds. The ECB has already reduced its balance sheet by more than 25% since starting QT, a faster pace than the Fed’s 17.5%. Meanwhile, the gap between Italian and German 10-year yields narrowed to 129 bps, a decrease of 4 bps over the week. In Japan, the Bank of Japan's first bond-purchase cut since December has driven yields to their highest levels since 2012. The 10-year Japanese yield is now approaching 1%, and the 30-year yield has surpassed 2%. This adjustment by the BoJ is part of its strategy to counter the Yen's depreciation without resorting to interest rate hikes.

Emerging market

Emerging market bonds excelled last week, buoyed by new economic initiatives in China and notable weakness in the US dollar. EM corporate bonds rose by 0.5%, with credit spreads tightening to their lowest levels since 2018 at 211 basis points. EM sovereign bonds enjoyed a gain of 0.9%, benefiting from their longer duration exposure. The standout performer was EM local currency bonds, which capitalized fully on the USD's weakness, with the VanEck J.P Morgan EM Local Currency Bond ETF posting a 1.5% gain, marking one of the best weeks of 2024 so far. China was at the forefront of emerging markets last week with the announcement of new measures aimed at accelerating the country's economic recovery. In the real estate sector, substantial policy easing is rejuvenating a vital part of the Chinese economy. Following Beijing's new directives, major cities like Hangzhou have removed all homebuying restrictions, potentially setting a precedent for other cities. This shift from a cautious policy stance to an aggressive reduction of housing inventories could significantly simplify the homebuying process and energize the market. Additionally, China has launched the sale of RMB 1 trillion ($140 billion) in long-dated bonds, with proceeds designated to stimulate the economy and fund long-term projects in critical sectors such as food security, energy, and manufacturing. This strategic move is designed to alleviate the debt burden on local governments and shift away from an over-reliance on property and infrastructure investments. The issuance of these bonds, with terms extending up to 50 years, marks a crucial step in modernizing China's economic framework and sustainably managing its debt. Against this backdrop, the Asian high-yield market has surged, now up almost 10% year to date.

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

Japan's Yield Curve is Steepening Again! 


Source: Bloomberg

Big moves in the Japanese bond market! The Japanese yield curve, which tracks the difference between 2-year and 10-year yields, has dramatically steepened since late March and surged even more in May. It's now at 63 bps, a level we haven't seen since January! 10-year and 30-year Japanese yields are hitting decade highs, approaching 1% and surpassing 2%, respectively. As the Yen weakens, the Bank of Japan stepped in to support the JPY and recently cut its bond-buying program for the first time this year. What’s next? The BOJ might sell off its US Treasuries holdings, potentially driving US Treasury yields up in the coming months. Higher Japanese yields also mean US Treasuries are less attractive to Japanese investors, who are key players in the US market. Last summer, a sharp steepening of the Japanese yield curve coincided with a major sell-off in US Treasuries...


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