- Investment Director
Finland, Institutional
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Welcome to June’s edition of Bonds in Brief, our monthly assessment of risks and opportunities within bond markets for fixed income investors. Each month, we explore material macro changes and how best to navigate the latest risks and opportunities we see within bond markets.
Key points
- Global bond yields declined marginally amid ongoing geopolitical tension and weakening growth indicators, and divergence across markets continued. US Treasury yields fell despite a scramble to pass US President Donald Trump’s tax and spending package by 4 July, while yields across much of Europe edged higher as the European Central Bank signalled a likely pause in rate cuts.
- Tariff negotiations continued to drive markets. In a welcome de-escalation, the US and China reached agreement on reciprocal tariffs, lowering rates to 55% on China and 10% on the US, from 145% and 125%, respectively. Despite some progress, a US-EU trade deal remained elusive.
- Rather than taking stock of a prolonged cycle to repair balance sheets and reduce budget deficits, governments in developed markets are continuing to opt for fiscal stimulus despite tight labour markets and a supportive economic backdrop. Costing an estimated US$3.9 trillion over the next decade, the US’s “One, Big, Beautiful Bill”, which became law on 4 July, is a case in point. Of particular relevance to foreign investors was the removal of the Bill’s Section 899, which would have imposed a 5% – 20% tax on US investments by entities from “discriminatory foreign countries” that the US Treasury would have deemed were imposing “unfair” taxes on US entities or persons.
What are we watching?
- Israel-Iran conflict. Middle East tensions escalated as US strikes on Iran’s three nuclear sites — Natanz, Fordow and Isfahan — caused significant damage. Iran responded by launching missile strikes targeting US military bases in Qatar and Iraq, which were intercepted. Many important questions are still unanswered, including the impact on Iran’s nuclear capabilities, the extent of Iran’s retaliatory actions and the likelihood of a short- or long-term conflict involving the US. Market reaction appears muted thus far, though the situation remains highly fluid.
- Energy prices. Oil prices initially spiked following the strike on Iran but quickly retreated after a ceasefire agreement between Israel and Iran. Worst-case scenarios for markets (such as attacks on regional oil infrastructure or closure of the Strait of Hormuz) remain a low probability, given substantial US military presence and capacity in the region. Still, a risk premium on oil prices is likely warranted given low inventories and geopolitical uncertainty — especially until surpluses materialise more directly in the fourth quarter. Energy price spikes tend to have distinct regional impacts. For instance, Europe is more dependent on natural gas than oil, and the Dutch TTF futures contract (a bellwether for European gas prices) moved in sympathy with oil prices over the period. Other large economies such as China, an oil importer, are also sensitive to spikes in oil prices. The extent to which commodity price changes feed into inflation and consequently policymakers’ decision making will depend on whether we see sustained increases or only temporary spikes.
- High-yield issuance. While the outlook for corporates isn’t necessarily clearer than it was on “Liberation Day” in April with regard to tariffs and the associated macro risks, we have since seen a reacceleration of borrowing by high-yield issuers. Corporate issuers have been quick to take advantage of the considerable recovery in prices and spreads after the widening earlier in the quarter, with European high-yield primary markets hitting an all-time high of €22.2 billion in June for single-month issuance. We saw similarly strong issuance in the US, with US$32 billion in June, the highest volume in nine months. Many of the names that came to market were of lower quality in nature as these issuers were keen to secure access to financing ahead of the (now delayed) 9 July deadline for reciprocal tariffs, which could have prompted another market shock.
- Doves becoming more vocal. Despite their support for keeping policy rates unchanged in June, Federal Open Market Committee (FOMC) Governors Christopher Waller and Michelle Bowman — both Trump appointees — have since publicly favoured rate cuts at July’s FOMC meeting. Waller’s views align with Trump’s stated wishes for current Fed policy. Bowman, who historically has been one of the more hawkish governors, has now softened into a near-term dove. President Trump is reportedly considering nominating Chair Powell’s successor early in order to undermine Powell’s authority and allow the “shadow chair” to influence expectations for monetary policy. We remain concerned about damage to institutional integrity, with Fed independence at the top of that list.
Where are the opportunities?
- The risks of a recession have increased yet tariffs are also likely to add to the current inflationary impulse. Given these dual risks, our key conviction remains a focus on higher-quality total return strategies that are less constrained by benchmarks. This could include global sovereign and currency strategies that have the potential to shine during these periods or unconstrained strategies that are able to navigate the late cycle by allocating across different sectors. These strategies could also enable investors to allocate capital away from cash and reduce reinvestment risk without taking on significant duration or credit risk.
- In a still volatile and uncertain market environment, we see core fixed income, whether aggregate or credit strategies, as increasingly attractive from both an income and capital protection perspective. All-in yields remain attractive for investors looking to derisk following the equity rally seen this quarter. And for European investors looking to protect themselves from ongoing volatility, high-quality income may offer an attractive avenue not just in local but also global markets.
- We think high-yield debt still offers potential, but advocate a cautious approach given market uncertainty and current spread levels. At the same time, the robust additional income potential may make high yield a good equity substitute should investors want to derisk. For all higher-yielding credit, we believe an “up-in-quality” issuer bias and careful security selection is warranted.
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