Over the past weeks, bond markets faced significant volatility primarily due to a barrage of announcements from the White House. The measures of new tariffs by President Donald Trump, including a 25% tariff on imports from Canada and Mexico effective on 4 March, and an additional 10% tax on Chinese imports, introduced uncertainty in the markets, exacerbated by the fact that some of these tariffs were revoked or postponed to a future date. In Europe, political events kept markets on their toes as a much-awaited election delivered a victory for Germany’s conservatives (CDU), and a coalition government is expected to deliver very significant fiscal stimulus (of over €900bn). This positive event for Euro growth is contrasted to the potential announcement of Trump tariffs on the EU, which is expected to have a negative impact on growth.
Central banks did not deliver any surprises over the month, with the Federal Reserve (Fed) dot plots pointing towards 2 rate cuts this year, and Fed rhetoric citing economic resilience and stable inflation, though expressing concern about the effects of tariffs. Elsewhere, the European Central Bank (ECB) Governing Council decided to lower the three key ECB interest rates by 25 basis points marking the 6th rate cut since June 2024.
In this context, US Treasury yields exhibited volatility during this period, but generally moved lower over the past month, ending at close to 4.3% (from previous levels of 4.6%), while rates in Europe rose substantially. The move was notable on the German curve that saw a material steepening, with the 10-year seeing the strongest rise. With both fiscal and monetary support acting in their favour, European risk assets outperformed their US counterparts. Indeed, in spite of yields that generally increased on the credit asset class both euro investment grade and high yield resisted thanks to decline in spreads.
Overall, the “Trump trade” that started in October of last year has seen unwinding over the month of February/March and markets are clearly weary of future tariff announcements. This adds to an already volatile environment where political, geopolitical and economic risk are ripe.
Over the month of February, the US labour market continued to gradually cool and consumer and producer prices remained sticky. Towards the end of the month, markets appeared to increase bets on further Fed easing, resulting from a string of relatively weak economic data that sparked concern about the outlook for corporate profits amid lofty equity valuations. So far, hard data on the economy appears to indicate that resilience remains, as indicators like Non-Farm Payrolls remained stable. Inflation numbers increased slightly and the ISM manufacturing report on business prices saw an upward spike.
Currently, market pricing has terminal rates at 3.5% and any economic shocks (like a potential recession) resulting from heightened tariffs from the US would clearly impact the terminal rate. Economic surprises and confidence indicators are falling, and surveys are also seeing downtrends as trade uncertainty is peaking and impacting investor confidence. In this context, we do see a downward trend on US 10-year rates and in the event of a risk-off scenario brought on by a continued downturn in markets, we hold a positive view on US rates that we aim to manage tactically.
After previously holding an overweight duration conviction on EUR rates, we tactically moved to a neutral position in anticipation of the German elections and increasing murmuring around the need for increased defence spending in light of the abrupt disengagement by the United States. This paid off, although we too were surprised by the extent of the latest German announcement.
European rate curves steepened on the increased need for defence spending, and the implied issuance in sovereign bonds, The €900bn fiscal stimulus promised by Germany has been strong and has already had an impact on rate markets. There has been a material steepening of the curve over the past few days. Indeed, the long end (over 50bps widening) has seen a much higher increase than the short end. As a result, the 10-year portion of the German curve (the BUND) has seen the highest increase and hence it is on this longer end that an opportunity has been created with yields at close to 3%. Indeed, upon the announcement the German 10Y saw its biggest one-day rate rise since reunification.
Aside from the recent rate cut, the ECB found confidence in the inflation prints from France, Italy, and Spain, while German inflation remained unchanged. Despite those varying trajectories, price pressures appeared to moderate overall and a slowdown in fourth quarter negotiated wages bolstered confidence that they would feed further into lower services inflation. ECB economists estimate that the neutral interest rate lies between 1.75% and 2.25%, and previous guidance has indicated that they want to reach neutral by June at the latest.
Markets are clearly watching and waiting for the Trump tariffs against Europe, and we expect this to be immediate, with a negative impact on growth, that is already slowing in the Eurozone. On the other hand, the German government will need to issue bonds to finance this strong fiscal support. This issuance is likely to put upwards pressure on 10-year rates. However, we do expect that issuance is not likely to be immediate but rather distributed across 2026 to 2028. Hence, this upward pressure is unlikely to materialise this soon, so the market might have overpriced this risk. In this context, the long end (Bund) should provide a good source of carry (close to 3%) and some potential yield compression. We tactically turned back overweight on German Bund in the second week of March, as we take advantage of the higher carry (an increase of nearly 0.5%) that has materialised. We continue to hold our steepening bias with a short position on the 30-year rates. However, it is important to note that all is not done on the fiscal stimulus. We will very closely monitor the debate on the stimulus and the eventual vote to see what happens (what concessions will be made, what will be implemented). While we do expect Trump tariffs, we also expect a lot of volatility and rhetoric around the event and hence, we aim to be nimble and tactical.
On a per-country basis, we retain our positive view on Spain, the sole large Euro Area issuer with healthy growth, while we continue to be cautious on France, given fiscal dynamics and political uncertainty. We have taken some profit on our Eastern European exposure reducing our exposure on the likes of Slovenia, Slovakia, Romania after their strong run.
Credit markets remained supported by strong investor demand and primary market activity was heavily subscribed with deals largely coming to market with little-to-no spread concessions. Notably, US blue-chip companies (e.g. T-Mobile, IBM, and some major Wall Street banks) have been raising euro debt lured by the lower borrowing cost, natural hedge for firms that do not need to swap it back to dollars, while benefiting from a diversification in their investor base. Fourth quarter 2024 earnings season in Europe and (to a lesser extent) in the US showed varied results across sectors, emphasising the importance of selective issuer picking in a market with compressed spreads. In recent days, the overall performance of European credit (though negative) has been relatively controlled. Over the past few days (since 28 February), Euro IG has lost 1.5%, primarily as a result of yields increasing sharply as spreads remained flat. Euro HY has lost about 1.0%, and indeed also suffered spread increases, but total returns suffered less thanks to higher carry.
The imminent Trump tariffs and the already weak macro-economic condition are likely to weigh on credit market fundamentals and drive spreads higher over the near-term. The fiscal support that Germany will provide is more likely to bear fruit from 2026 onwards and hence unlikely to weigh on spreads in 2025. On valuations, what can be seen is that yields have improved on IG (and to a lesser extent on HY). This is a good carry opportunity for investors. However, spreads are at multi-decade tights and hence very vulnerable to a rate rise. Technicals in IG over the near term should still be well supported as investors continue to pile into the asset class, as they look to lock in carry in a high-quality asset class. In spite of a large issuance, it seems to be well absorbed, and the appetite is expected to remain alive. However, on high yield we not only see outflows from investors, but it is possible that issuance returns and further weakens technicals.
In this context, we think Euro IG remains a strong asset class, benefiting from carry and quality. However, in the very immediate future, we do see Trump tariffs as a negative impact and hence tactically hold a neutral stance as we wait for strong entry points. On High Yield, we have moved towards a negative stance, as both spreads and yields have the potential to widen from currently restrictive levels. It is important to note that in all cases, we remain selective, focusing on bottom-up research to pick the best opportunities that arise across markets. We aim to carefully monitor the construction and materials sector, while also keeping a keen eye on German credits that could benefit from the current context.
US Credit is undoubtedly expensive across most of the quality spectrum. Nonetheless, despite this richness, we are comfortable holding a neutral exposure to investment grade credit. This is thanks to high all-in yields and the buffer against possible spread widening this high carry offers. High Yield valuations are arguably even richer, though they have seen some widening. Fundamentals are still decent but trending weaker. However, high yields and low duration do offer a substantial degree of protection. In this context, we hold an underweight stance.
We return to a neutral from a positive stance on the dollar, which we had implemented vs select currencies, but not vs EUR. Recently, the economic surprises in the US and Eurozone have inverted, the rates differential has compressed, and the extreme short positioning on the Euro has reduced. This should improve the relative attractiveness of EUR assets and reduce flows into the greenback.
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