- Investment Director
France, Intermediary
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Welcome to December’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
- Government bond yields rose in most regions in December, maintaining the upward trend from late October. Spreads tightened modestly across a broad range of sectors, leading to excess returns relative to government bonds.
- Global credit spreads ended the year just below 80 basis points — a level rarely seen in the past 15 years. Underlying fundamentals remain strong, thanks to healthy private sector balance sheets. However, it’s important to closely monitor corporate actions, as this stage of the market cycle presents opportunities to differentiate between issuers. Notably, continued debt issuance in sectors linked to the AI theme could trigger short-term spread widening. Elevated yields are driving demand from both short- and long-term investors, especially insurers and short-term fixed maturity funds.
- Despite persistent inflation and geopolitical uncertainty in 2025, risk assets were supported by resilient corporate earnings and AI-driven investment themes. Credit markets delivered mid-to-high single-digit gains over the year, aided by tighter spreads and strong fundamentals. Many fixed income sectors posted high-single-digit gains as falling policy rates offset volatility in long-term yields.
- 2026 begins with global government bond yields above 3% and credit spreads at multi-year tights. Amid continued policy uncertainty, tariff risks and questions about AI profitability, security selection and diversification remain critical in navigating the next phase of the cycle.
What are we watching?
- Venezuela. On 3 January, the US military attacked Venezuela and detained President Nicolás Maduro, transporting him to a Manhattan federal court to face narcoterrorism charges. Geopolitical risk has reemerged as a dominant factor and is likely to command investor attention for the foreseeable future. While developments in Venezuela remain fluid, early indications point to limited market disruption and no broad regional conflict. The swift leadership change in Venezuela, with Delcy Rodríguez replacing Maduro, indicates potential short-term economic stabilisation, but the country faces a slow recovery in oil production due to infrastructure issues and ongoing political uncertainty. Lower oil prices could ease inflation, though prices are already starting from below US$60 a barrel (traditionally considered low). This pivotal event highlights increasing geopolitical fragmentation and suggests that domestic political tensions in the US could intensify, especially around budget negotiations if party control shifts in 2026.
- French political risk. French political risk has diminished in the near term after Prime Minister Sébastien Lecornu brokered a deal with the Socialists to delay pension reform until after the 2027 presidential election, a move that garnered support from the centre-right and helped him survive two no-confidence votes. While the likelihood of imminent elections has decreased, the government’s narrow majority keeps some risk of early elections alive. Fiscal challenges persist, as Lecornu is expected to allow the deficit to approach 5% of GDP, signaling a more gradual fiscal adjustment than previously planned and leaving France’s longer-term debt outlook unresolved. Although passing a 2026 budget could provide temporary stability, continued structural and fiscal uncertainties, combined with the suspended pension reform and upcoming elections, are likely to keep French bond spreads elevated and sensitive to political developments.
- The European cycle. Despite significant geopolitical events in 2025, the euro area outpaced expectations, with growth near 1.5% aided by loose financial conditions and supportive fiscal policies. While the absence of US tariff shocks could have led to even stronger growth, risks remain for 2026, including potential headwinds from US and Chinese trade protectionism, uncertainties surrounding the effectiveness of German fiscal stimulus and possible erosion of market confidence in French sovereign debt, particularly as the 2027 presidential election approaches. Conversely, should a sustained ceasefire occur in Ukraine, this could spur growth by unlocking substantial household savings, which have notably contributed to the persistent growth gap between the US and euro area since 2020.
- Fed independence. The oral arguments for Governor Lisa Cook’s case — centred on whether the US president can lawfully remove a Fed governor — will come before the Supreme Court in early January, and the announcement of Fed Chair Jerome Powell’s replacement in the coming weeks will give us a clear indication of the extent of pressure exerted by the US administration on the central bank.
Where are the opportunities?
- The risks of a recession remain modest, 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 (especially those that diversify US-dollar exposure) that allocate across multiple sectors.
- In a still volatile and uncertain market environment, we see core fixed income, whether aggregate or credit strategies, as increasingly appealing from both an income and capital protection perspective. All-in yields remain attractive for investors looking to derisk or diversify away from domestic government bonds, providing a potentially smoother return profile. And for European investors, 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 are warranted.
Expert
