Fixed Income – Monthly Expert View – April 2025

March saw US tariff rhetoric drive significant volatility in financial markets. The US implemented several new tariffs, targeting imports from China, Hong Kong, Canada, and Mexico. In retaliation, Canada, China, and Mexico imposed levies on American goods, exacerbating uncertainty regarding future inflation and economic growth. 

Month in review

Notably, US consumers' inflation expectations rose, with the University of Michigan's long-term measure climbing to 4.1% in March, the highest level since February 1993. The three-month annualised rate of the core personal consumption expenditure index (PCE) -- the Federal Reserve's preferred measure of inflation -- was 3.6% in February, its highest level since March 2024. At its meeting, the Federal Open Market Committee (FOMC) opted to maintain policy rates at their current levels, with Chair Jerome Powell stating that although inflation had decreased significantly from its mid-2022 peak, it remained somewhat elevated.

Against this backdrop, investment grade (IG) corporate bond spreads across the US, Europe, and the UK all widened during the month. The convergence in spreads across geographies over recent months means that ranges are much tighter. Total returns in March were negative across all markets given government bond yields did not manage to offset the spread widening, with US Treasury yields remaining constant, while those of German bunds and UK gilts rose sharply.

In high yield (HY), the global index returned -0.9% during March, dragged down by wider credit spreads in another volatile and risk-off month for markets. Uncertainty over trade policy keeps clouding global growth expectations, and markets keep struggling to price in potential implications from tariffs and inflationary pressures. Global HY floating rate notes (FRNs) outperformed (0.0%) traditional HY markets, mainly a result of their lower market beta mitigating capital loss from wider spreads.

In emerging markets (EM), local currency (LC) sovereigns returned 1.5% in March (4.3% YTD), with hard currency (HC) sovereigns at -0.8% (2.2% YTD) and HC corporates at 0.1% (2.4% YTD). The negative returns in HC sovereigns were driven primarily by widening spreads in high yield sectors, affected by specific issues in Turkey, Lebanon, and Ecuador, amid a broader risk-off sentiment due to tariff fears and US policy uncertainty. Conversely, LC markets benefited from a weakening US dollar. 

Inflation

US inflation came in softer than expected in February, with headline inflation at 2.8% compared to the anticipated 2.9%. Additionally, core CPI recorded its lowest reading since 2021, at 3.1% versus the forecasted 3.2%. While much of the current focus is on goods inflation, particularly due to the anticipated impact of tariffs, little time is spent considering the other, and arguably more significant, component of the inflation narrative: service inflation. While core goods inflation is reaccelerating, albeit from a very low level, service inflation is decelerating, thereby keeping overall inflation in check. Specifically, rents continue to normalise downward, and supercore inflation, the category most closely monitored by the Fed, has declined further, reflecting a weakening labour market and lower wage growth.

Despite extensive discussions about tariffs and their potential to significantly increase prices, there has been limited consideration of the impact on prices of other categories not affected by tariffs. It is relatively straightforward to assume that core goods inflation will likely rise, primarily driven by tariffs. However, the key question is what the impact will be on core services, where tariffs have a more limited effect.

To address this question, it is important to incorporate money supply into the discussion. Tariffs, like other factors, influence relative prices but do not necessarily affect the absolute price level. If tariffs are implemented while the amount of money in the system remains unchanged, consumers will have to spend more on tariff-impacted items, but will have less money to spend on other items, thereby driving the prices of these other items lower. Conversely, if tariffs are accompanied by an increase in money supply, the higher prices on tariff-impacted items may not necessarily affect other items, potentially driving the overall absolute price level higher rather than merely impacting relative prices.

While money supply has accelerated in recent months, it did so from a very low level and it remains relatively contained historically. This suggests to us that most of the increase in prices from tariff-related items will likely translate into subsequent declines in other items.  

In summary, while the current focus is on goods inflation, where the impact of tariffs will be more pronounced, little time has been spent understanding what will happen to the other part of the inflation basket. Tariffs have a near-term inflationary impact, but if they are not followed by an increase in money supply, their impact will likely be short-lived as consumers will need to spend less on other items, causing the price of those items to decline.

Developed market sovereigns

Tariff rhetoric marked March as a very volatile month in financial markets. The US implemented several new tariffs in the month including additional duties on imports from China, Hong Kong, Canada, and Mexico. Canada, China and Mexico imposed levies on American goods in response, which increased the uncertainty regarding future inflation and growth. On 4 March, Germany announced a significant fiscal spending package expected to stimulate economic growth and address the country's contracting economy. German bunds sold off strongly as a result.

In the US, consumers’ inflation expectations moved higher, and the University of Michigan’s long-term measure moved up to 4.1% in March, the highest since February 1993. The latest PCE inflation data, which is the Fed’s preferred measure of inflation, showed the three-month annualised rate of core PCE was running at 3.6% in February, the highest since March 2024. At the same time, there were growing concerns about the US growth outlook, feeding the fears about stagflation. The Conference Board’s consumer confidence measure fell to just 92.9 in March, the weakest since January 2021, while the expectations measure fell to 65.2, the lowest since March 2013. The FOMC decided to leave the policy interest rate unchanged. Powell stated that inflation had come down significantly from its peak in mid-2022 but remained somewhat elevated. He noted that the path to sustainably returning inflation to the 2% target had been bumpy and was expected to continue being so. The FOMC median projection for total PCE inflation was 2.7% for 2025. On the growth side, Powell mentioned signs of a possible moderation in consumer spending. The Fed’s median projection for GDP growth is 1.7% for 2025 (versus 2.3% in Q4 2024).

In the eurozone, the European Central Bank (ECB) lowered key interest rates by 25 bps. Persistently high geopolitical and policy uncertainty was expected to weigh on eurozone economic growth. This uncertainty affected exports and investment, leading to a decline in the area's export market share. The fiscal stance was projected to tighten slightly in 2025 and remain neutral in 2026. The ECB also expects GDP growth at 0.9% for 2025 (which reflects a slight downward revision from previous forecasts due to lower exports and ongoing investment weakness) and headline inflation is projected to average 2.3% in 2025, driven by stronger energy price dynamics.

In the UK, the Office for Budget Responsibility (OBR) halved the growth forecast for 2025 from 2% to 1%. This revision was attributed to weaker-than-expected economic performance and global uncertainties. They also projected inflation to average at 2.5% in 2025 reflecting ongoing pressures from energy prices and supply chain disruptions. On a more positive note, the unemployment rate is expected to remain stable showing resilience despite the economic challenge.

Past performance is not a guide to future performance.

^{Source: Bloomberg, 31 March 2025}

Investment grade credit

In March, the global economy faced significant turbulence driven by major tariff announcements from President Trump. A pivotal event occurred on 31 March 2025, when reports highlighted Trump’s plan to impose tariffs on all countries, a move that escalated fears of a global trade war and potential recession. This announcement triggered widespread market volatility, with safe-haven assets like gold experiencing increased demand. The tariffs were perceived as a threat to global trade, contributing to a sharp slide in US manufacturing activity and a surge in prices, as noted in economic reports from that date.

On 4 March, Germany announced a significant fiscal spending package aimed at stimulating economic growth and address the country's contracting economy, as a result German yields sold off strongly. The International Monetary Fund (IMF), in its World Economic Outlook published on 30 March 2025, projected global growth at 3.3% for both 2025 and 2026. However, this forecast came with caveats, as tariff uncertainties weighed heavily on economic sentiment. These developments underscored a challenging economic environment marked by inflation anxiety, trade policy uncertainty, and softening economic data. Against this backdrop, across the US, Europe, and UK, spreads on IG corporate bonds widened in March 2025. The convergence in spreads across geographies over recent months means that ranges are much tighter. Total returns across all markets were negative as government bond yields did not offset the spread widening.

Past performance is not a guide to future performance.

^{Quelle: Bloomberg, 31. März 2025}

High yield credit

The Global HY Index returned -0.9% dragged down by wider credit spreads in another volatile and risk-off month for markets. Uncertainty over trade policy keeps clouding global growth expectations, and markets keep struggling to price in potential implications from tariffs and inflationary pressures.

Global HY FRNs outperformed (0.0%) traditional HY markets, mainly as a result of their lower market beta mitigating capital loss from wider spreads. HY spreads rose across all regions, with US HY seeing the largest widening to end at around 355 bps – a more compelling level in absolute terms, and relative to Europe, as it’s the first time since 2023 that the US index trades wider. European spreads currently stand at 336 bps while EM HY spreads stand at 386 bps at month end. Across regions, US HY underperformed (-1.1%) versus Europe HY (-0.9%) and EM HY (-0.1%) which fared a little better.

Tariff/inflation/growth concerns weighed down US HY sentiment while euro HY sentiment was better supported by expectations for potentially better-than-anticipated growth on the back of recently announced fiscal policies. Across ratings, as would be expected, higher quality outperformed, with CCCs underperforming across both US and EU.

All sectors in the US posted negative returns with Food and Energy generally holding up better, and Media and Retail underperforming (albeit with some issuer-specific moves within those sectors). Primary markets have been busy with refinancing activity, particularly from non-financials. Activity was dominated by BBs while issuance in B rated remains more subdued. CCC activity remains muted, underpinning the challenges for issuance in the lower end of the HY rating stack. As a result, the market technical remains very strong with shallow levels of net issuance and the ongoing market shrinkage due to issuers moving to seek financing in private markets.

Going forward 

We remain reasonably close to neutral, not pushing out too far underweight or overweight risk. Spreads arguably are looking more interesting today, but not yet necessarily compelling enough to materially add risk given recent uncertainties. March has been a turbulent month for markets, particularly in the US. Some flags are being raised in regard to slower growth and inflation risks, but it is worth remembering that only a few months ago, risk assets were hitting record highs. Markets have been getting used to good news and, when anything less than good comes along, they sell off. We are likely to see further corrections as macroeconomic and market expectations readjust and find some balance.

In today’s uncertain policy and geopolitical environment, we believe that HY remains an interesting space for investors looking to capture elevated yield, with potentially lower levels of interest rate risk.

Here is why: 

• High single-digit yields: while spreads may be low (even after the March rebound), yields on HY bonds remain historically elevated. In a carry-driven year, there is scope to generate high single-digit returns, in our view.
  
  
• Short duration: HY markets have shorter durations compared to other fixed income instruments (IG or government bonds). This reduces their sensitivity to swings in interest rates, helping mitigate capital loss.
  
  
• Expectation of benign default cycle: although interest rates remain historically elevated and economic growth is slowing, distress levels have been dampened by interest rates starting to trend lower and frequent refinancings taking place. Current distress ratios are still consistent with a sub 3% default rate for the next 12-18 months.

• HY fundamentals are resilient : despite macroeconomic uncertainty, particularly when it comes to net leverage (which is not increasing due to a lack of M&A activity) and interest coverage ratio (which is still above levels at which analysts would typically become concerned). 

• An active approach is crucial: even with generally healthy corporate balance sheets and conservative management, the low levels of initial public offerings (IPO) and leveraged buyout (LBO) activity bring risks of alternative shareholder-friendly (and bondholder negative) events such as dividend recapitalisations. Careful analysis of downside protection elements such as bond covenants prior to investing in HY credits is crucial to make sure credit spread appropriately compensates for the risks undertaken.

Past performance is not a guide to future performance.

^{Source: Bloomberg, 31 March 2025}

Emerging market bonds

The hard currency sovereign index delivered negative returns during the month, driven by spreads widening particularly in the HY space where a number of country-specific stories weighed on the likes of Turkey, Lebanon, and Ecuador. Markets also repriced on the back of a general risk-off sentiment over fears of tariffs, a US slowdown, and the increasing uncertainty in policy from the US.

The local currency market was the clear outperformer during the month, benefiting from a US dollar which weakened for a third consecutive month. Lower-rated countries largely drove the negative returns of the hard currency index.

March saw a continuation of uncertainty stemming from US policy, particularly tariffs, with risk-off sentiment driving market returns. Uncertainty continues to overshadow EM which, in isolation, look to be in a fairly good position but are continuously having to grapple with headwinds from the US. Trump has once again widened the potential scope of tariffs with all nations and trading blocs seemingly in his firing line. The good news within EM is that inflation is broadly under control, although there are some outliers in the likes of Brazil and Chile, who were particularly quick to cut rates following the initial post-COVID inflationary pressures. Strong levels of economic growth are also expected, with the EM versus developed market (DM) premium continuing to widen, also driven by the modest growth levels expected in Europe. EM companies are in good shape, with fundamentals appearing favourable, with a relatively low level of defaults expected in the HY space. Sovereigns, equally, are broadly speaking in good shape with no defaults expected in the near term.

Past performance is not a guide to future performance.

_{Source: Bloomberg, 31 March 2025}

Currencies

The US dollar saw a fairly significant decline during the month, as measured by the DXY Index, falling 3.16%. This marks a three-month run of the dollar declining, albeit falls in January and February were more modest at 0.9% and 0.7%, respectively.

The continued rhetoric and escalation of tariff threats are weighing on growth prospects in the US, with questions arising over how quickly US exceptionalism could turn into a stagflation story, with growth falling and inflation rising. The increased uncertainty led to a risk-off tone, with US assets particularly selling off.

A weakening dollar was broadly positive for major currencies during the month, except for those suffering from their own specific stories, such as Turkey. The Swedish Krona, Norwegian Krone and Danish Krone continued their run of being significant outperformers and are now amongst the top performing currencies of the year (aside from the Russia ruble, which has strengthened markedly on hopes that the conflict will end and sanctions will eventually be lifted).

The Scandi trio have seemingly become a proxy for a European recovery, with swathes of spending promised by the European powerhouses such as Germany. With growth within the Scandinavian region also expected to outstrip that seen within the eurozone, markets are reflecting an expected continuation in divergence between central bank policies.

The Turkish lira came under notable pressure after President Erdogan moved to imprison the Mayor of Istanbul, Ekrem İmamoğlu, widely perceived to be his nearest political rival.

Analysts have suggested the move could indicate that Erdogan is manoeuvring to force a snap election.

This would be his best chance to sit another term as President, which would be currently outlawed by the Turkish constitution owing to the number of terms Erdogan has already served.

While the Turkish lira initially fell by 10% (versus USD), it ended the month down 3.9% as the central bank intervened to prop up the currency.

Past performance is not a guide to future performance.

_{Source: Bloomberg, 31 March 2025}

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested.

The views expressed in this document should not be taken as a recommendation, advice or forecast.

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