Bonds in brief: making sense of the macro — March issue

Marco Giordano, Investment Director
4 min read
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Welcome to the March 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

  • Mixed economic data left market participants grappling with the expected timing and magnitude of central bank rate cuts. In a notable switch from February, with inflation in the euro area moderating at a faster rate than in the US, futures markets are now assigning a higher probability of a rate cut by the European Central Bank (ECB) than the US Federal Reserve (Fed) at their June policy meetings. 
  • In a widely anticipated move, the Bank of Japan (BOJ) announced that it would end its negative interest-rate policy, a landmark shift away from its decades-long stimulus programme to combat deflation. While the small hike, from -0.1% to a target range of 0% – 0.1%, is unlikely to be followed by significant monetary tightening, it marks a notable shift as the BOJ was the last major central bank still adopting negative interest rates. 
  • Elsewhere, the Swiss National Bank surprised markets with a 25 basis points rate cut as policymakers became confident that inflationary pressures have abated, causing the Swiss franc to continue depreciating against other currencies. The Bank of Mexico became the latest central bank in Latin America to start its rate-cutting cycle, and could follow Brazil, Chile and Colombia in further reducing interest rates.

What are we watching? 

  • Narrowing window for rate cuts. Inflation is on a downward trajectory in many countries, and we are seeing signs of slowdowns in labour markets too. However, unemployment is not picking up significantly and, in some countries (notably, the UK and across Europe), hiring intentions remain stronger now than at the same time last year. Global purchasing managers’ indices appear to have troughed above 50, with manufacturing in growth territory for the first time since mid-2022 and services continuing to expand. While inflation data hasn’t changed sufficiently to move the Fed and other central banks away from their intention to start easing in the summer, there is a real risk of the cycle reaccelerating without inflation having reached target first. In this context, the window for policymakers could be narrowing if underlying economic data doesn’t allow them to follow through on expected rate cuts. 
  • High-yield spreads continued to compress, with CCC rated issuers leading the way in the US. While economic conditions remain relatively robust, there are rumblings under the surface. Levered French telecom giant Altice faces corruption probes in France and Portugal. This case is notable because Altice is a significant component of European high-yield indices, and its leveraged loans are embedded in many collateralised loan obligation (CLO) structures. Its most recent ratings downgrade to CCC means that it can impact over-collateralisation tests in CLOs, which could potentially lead to forced sales of the securities. 
  • Upcoming elections in India and Mexico will give more than one billion people the chance to vote. In both countries, policy continuity is likely if, as widely expected, Indian Prime Minister Narendra Modi wins a third term and Claudia Sheinbaum, a close ally of incumbent President Lopez Obrador, wins in Mexico. In South Africa, if the African National Congress fails to win late May’s election outright for the first time since the end of apartheid in 1994, a potential coalition government could put pressure on risk assets and the rand. Elsewhere, a possible shift to the right in June’s European Parliament elections could have significant implications for several policy areas, while in the UK, a Labour victory in a general election this year would be unlikely to change the country’s fiscal trajectory. In the US, November’s election has implications for tariff and tax policy, as well as the regulatory framework for a number of sectors. US term premia could be vulnerable to ballooning federal deficits and selling from large overseas holders of Treasuries, but the US dollar’s reserve currency status could mitigate some of these adverse effects.

Where are the opportunities? 

  • Given how drawn out and uncertain the rate cycle has been, we continue to see opportunities in higher-quality total return strategies that are less constrained by benchmarks. This could include global sovereign and currency strategies or unconstrained strategies that are able to navigate the late cycle by allocating across different sectors.
  • In our view, core fixed income, and particularly credit, strategies are looking increasingly attractive. Higher-quality fixed income is appealing from both an income and capital protection perspective, with the income from these strategies not only attractive outright but also providing an additional buffer to rate volatility. 
  • We think high-yield and emerging markets debt still offer potential, but we expect continued volatility given how late we are in the cycle and the normalising of default rates relative to current spreads. However, the robust carry may make high yield a good equity substitute. For all higher-yielding credit, including high yield, bank loans and convertible debt, we advocate an “up-in-quality” issuer bias in case the slowing economy undershoots a soft-landing scenario and defaults and downgrades accelerate.

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