Gaël Fichan

Head Fixed Income & Senior Portfolio Manager

What happened last week?

Central banks

Following the tariff shock on April 2nd, last week marked a shift from a trade spat to a broader economic confrontation between the U.S. and China. Meanwhile, the U.S. administration offered a 90-day pause on new tariffs for other trade partners, temporarily defusing tensions with Europe and North America. Against this backdrop, uncertainty around global growth and inflation trajectories remained exceptionally high. In the United States, the U.S. dollar and Treasury markets experienced extraordinary volatility, with signs of substantial capital outflows suggesting that global investors may be questioning the safe-haven status of U.S. assets. The sharp rise in long-end Treasury yields and a concurrent slide in the dollar raised concerns that the Greenback’s reserve currency role is increasingly under scrutiny. Several Federal Reserve officials acknowledged this more complex macro backdrop. Comments throughout the week reflected dual concerns: downside risks to growth and upward pressures on inflation stemming from tariffs. Even as March’s CPI and PPI inflation prints came in slightly softer than expected, markets remained focused on what lies ahead. With April ushering in a new tariff regime, the inflation landscape could shift materially in the months to come. As a result, futures markets revised their Fed rate cut expectations downward. Investors now price in only three 25bp cuts by year-end, down from four cuts just a week earlier. The Fed’s balancing act is growing more precarious—too slow on cuts, and growth risks deepen; too fast, and inflation could reaccelerate under tariff pressure. In the Eurozone, the temporary tariff suspension provided limited relief. A 25bp ECB rate cut is still widely expected this week, with two more priced in by year-end. However, recent euro strength and falling energy prices could suppress inflation in the coming months—opening the door to further easing later in the year. In Switzerland, the surge in the Swiss franc against the dollar—approaching levels last seen during the 2011 currency crisis—has led markets to price in a return to negative rates. Futures now reflect a chance of sub-zero SNB policy rates by June, signaling a dovish shift as currency strength threatens the economy. In the UK, stronger-than-expected economic data and upward pressure on long-term yields kept monetary policy expectations stable. Markets continue to anticipate three 25bp rate cuts in 2025, with the first move still forecast for May. As inflation persists and global volatility rises, the BoE may opt to tread cautiously.

Credit

Credit markets endured a turbulent week as the sharp surge in U.S. Treasury yields—driven largely by hedge funds rapidly unwinding leveraged Treasury basis trades—triggered widespread dislocations across the funding and credit space. The rate spike effectively froze the U.S. primary corporate bond market for most of the week, limiting issuance to a few names with minimal direct exposure to tariff risks, including Japan Tobacco and Transurban, the Australian toll-road operator. The U.S. administration’s unexpected 90-day pause on reciprocal tariffs helped ease immediate concerns of an escalating trade war, temporarily shifting the narrative from retaliation to renegotiation. But that pause did little to alleviate growing fears around U.S. growth and financial market fragility. In fact, the week was marked by historic fund outflows:

  • U.S. high yield (HY) experienced its largest weekly outflow in nearly two decades
  • EUR HY outflows approached levels not seen since the pandemic’s peak
  • EUR investment grade (IG) saw the biggest weekly outflows since 2020

In performance terms, U.S. IG spreads widened 4bps to 118bps, and the Vanguard USD Corporate Bond ETF fell sharply by -2.1% on the week, pushing its YTD return into negative territory (-1.0% YTD) as Treasury yields surged. EUR IG held up better, despite spreads widening by 6bps to 119bps. The iShares Euro IG ETF was flat on the week (-0.9% YTD), supported by the relative stability in Bund yields. Since April 2nd's "Liberation Day," European bank senior and utilities have been the standout performers in EUR IG. In high yield, U.S. HY spreads surprisingly tightened by 19bps to 426bps, partially retracing the previous week’s widening. The iShares USD HY ETF gained +0.8% on the week (-1.5% YTD). In contrast, EUR HY spreads widened sharply by 33bps to 412bps, though the iShares Euro HY ETF also managed a +0.8% weekly gain (-1.4% YTD) thanks to rate sensitivity. High-beta segments bounced:

  • European corporate hybrids fully rebounded, gaining +1.2% (-1.1% YTD)
  • WisdomTree AT1 CoCo ETF recovered +0.3% (-2.1% YTD) after a sharp selloff

Looking ahead, credit spreads are likely to remain volatile. The market is increasingly concerned that the U.S. economy is now absorbing multiple simultaneous shocks—a combination of tariff-related supply pressures, weakening demand, and the negative wealth effect from falling equity markets.

Rates

Last week marked a historic selloff in U.S. Treasuries, with the market recording its worst weekly performance since 2001. The iShares USD Treasury ETF plunged -2.4%, driven by a dramatic surge in yields across the curve. The 10-year U.S. Treasury yield jumped by nearly 50bps, ending at 4.49%, up from 3.99% just days earlier. Meanwhile, the 30-year yield surged to 4.87% from 4.40%, signaling intense selling pressure, particularly at the long end. Notably, this move was entirely driven by real yields, with market-based inflation expectations (breakevens) barely budging. The 10-year U.S. real yield spiked to 2.3%, one of the highest levels in recent years. What’s behind this sudden repricing? Multiple forces are at play:
-    A broad-based rally in the yen, euro, and Canadian dollar hints at foreign central banks offloading Treasuries, possibly to shore up domestic currencies.
-    China may be selling U.S. Treasuries to defend the yuan, as renewed tariff threats put depreciation pressure on the currency.
-    Elevated equity volatility (VIX near 50) has triggered widespread hedging and de-risking among asset managers across asset classes.
But the most likely culprit is the massive unwinding of the leveraged Treasury basis trade—an arbitrage strategy that involves exploiting small discrepancies between Treasury bond and futures prices. With as much as $1 trillion tied up in this trade, forced liquidations are adding significant upward pressure on yields. As a result, the MOVE index (the Treasury market’s equivalent of the VIX) soared to 140, its highest level since October 2023, underscoring the surge in rate volatility. Liquidity conditions have also deteriorated, especially at the long end, with bid-ask spreads widening to their worst levels since 2023. In Europe, the rise in yields was far more contained. The 10-year German Bund yield was flat on the week at 2.57%, as core European bonds offered relative stability. However, peripheral spreads widened, with the Italy-Germany 10-year yield differential climbing to 125bps, up 7bps on the week—reflecting growing concerns about fiscal divergence within the Eurozone. Despite the volatility, shorter-dated European debt held firm. The iShares EUR 3–7 Year Government Bond ETF posted a modest +0.1% gain, highlighting demand for defensive duration in a world of rising long-term yield risk. With Treasury volatility reaching extremes, the key question now is: Have markets fully digested the basis trade unwind—or is more pain to come?

Emerging market

Emerging market (EM) bonds faced significant pressure last week as escalating global trade tensions—especially the announcement of new U.S. tariffs—sparked a broad-based risk-off shift across financial markets. Fears of a potential U.S. recession compounded the volatility, with EM assets bearing the brunt of investor caution. In hard currency, sovereign debt led the decline. The iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) recorded outflows of $215 million, its largest weekly withdrawal in a month. Sovereign bond prices fell sharply, with spreads widening by more than 50bps since the start of April—back above 300bps for the first time since September 2024. EM sovereign bonds are now down -3% month-to-date. The hardest-hit names were concentrated in frontier and lower-rated credits. Ecuador (-11%), Ghana (-10%), Angola (-10%), Kenya (-9%), Ukraine (-8%), and Nigeria (-8%) led the declines. Even investment-grade sovereigns were not spared, with significant losses in Kazakhstan (-5%), Panama (-5%), Philippines (-4%), and Romania (-4%). On the more resilient end of the spectrum were Brazil, Paraguay, Oman, and Turkey (all -2%), along with IG names like China (-1%), Abu Dhabi, Qatar, and Poland (all -2%). The EM corporate bond space fared only slightly better, posting a -3% decline since April began, with credit spreads widening 85bps since mid-February. Investor demand has weakened notably amid growing concerns over refinancing risk and sensitivity to U.S. rates. In contrast, local currency EM bonds offered a rare bright spot. The VanEck J.P. Morgan EM Local Currency Bond ETF (EMLC) is up +0.8% month-to-date and +5.1% year-to-date, reflecting the relative strength of currencies and local monetary policy buffers in some economies. Interestingly, Latin American assets have outperformed global peers, emerging as relative winners in this environment. The MSCI LatAm equity index has beaten the S&P 500 by over 20 percentage points in 2025, as investors rotate toward regions perceived to be more insulated from the U.S. tariff war. This shift underscores how regional dynamics within EM are driving dispersion across asset classes. While risks remain elevated, especially in lower-rated sovereigns, investor rotation into local bonds and LatAm equities signals that selective opportunities still exist—provided markets can weather further trade policy shocks.


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

Basis Trade Unwinds — When Arbitrage Turns Into Avalanche!     

20250414_cow

Source: Bloomberg

Last week’s violent surge in U.S. Treasury yields wasn’t just about tariffs or inflation—it was the unwinding of one of Wall Street’s most leveraged trades: the basis trade. Hedge funds had piled into this strategy—buying cash Treasuries and shorting futures, aiming to profit from tiny price differences. But when bond prices dropped sharply, those spreads widened instead of converging, triggering margin calls and forced selling. With some funds leveraged 30:1, the liquidation spiral pushed yields even higher, fueling a classic feedback loop. At the peak, the spread between 10-year Treasury yields and swaps hit 64bps—an all-time high—while liquidity in the world’s safest market briefly vanished. This wasn’t just a selloff. It was a structural stress test. Could similar hidden leverage trigger the next big shock?Last week’s violent surge in U.S. Treasury yields wasn’t just about tariffs or inflation—it was the unwinding of one of Wall Street’s most leveraged trades: the basis trade. Hedge funds had piled into this strategy—buying cash Treasuries and shorting futures, aiming to profit from tiny price differences. But when bond prices dropped sharply, those spreads widened instead of converging, triggering margin calls and forced selling. With some funds leveraged 30:1, the liquidation spiral pushed yields even higher, fueling a classic feedback loop. At the peak, the spread between 10-year Treasury yields and swaps hit 64bps—an all-time high—while liquidity in the world’s safest market briefly vanished. This wasn’t just a selloff. It was a structural stress test. Could similar hidden leverage trigger the next big shock?

Disclaimer

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