Bonds in Brief: Making Sense of the Macro — April issue

What are we watching?

• Central bank independence. Global markets are increasingly sensitive to signs of political influence on central banks, highlighted by an unprecedented cabinet presence at April’s Bank of Japan policy meeting. Should doubts over central bank independence deepen, the consequences could include higher term premia, renewed currency pressure and increased market volatility. Japan also intervened again in currency markets to defend the yen, which had been trading around near 160 versus the US dollar. While the official size of the intervention is uncertain, estimates of US$ 40 – US$50 billion suggest that Japan’s Ministry of Finance has ample reserves to defend the currency from disorderly weakening, at least in the near term. Over the longer term, however, intervention alone is unlikely to sustain a stronger yen, with more persistent rate hikes needed to support meaningful appreciation.
• A prolonged conflict in the Middle East. Energy and shipping premiums remain structurally elevated, reflecting the risk of disruption at key shipping chokepoints as a persistent feature rather than a one‑off shock, with implications for inflation sensitivity and volatility across rates and credit markets. To date, businesses have largely absorbed the Iran conflict-driven oil shock through margins, limiting immediate inflation pass‑through. If energy prices remain elevated, that buffer may erode, increasing the risk of delayed price increases or weaker profitability later this year.
• Credit market complacency. Despite elevated uncertainty, credit markets continue to price a relatively benign outcome. Investors remain focused on persistent inflation risks stemming from the Middle East conflict, but credit spreads remain tight by historical standards, reflecting confidence in resilient growth and issuer fundamentals. In our view, this leaves markets vulnerable to underappreciated risks. Notably, AI‑driven capex is generating sustained financing needs, increasingly being met through public bond markets, while private credit continues to introduce opacity and refinancing risk beneath the surface. These forces point to rising leverage, heavier supply and greater dispersion over time, but these dynamics are not yet fully reflected in valuations. While we do not see an imminent credit shock, the combination of tight spreads and growing structural pressures suggests limited margin for error should growth slow or financial conditions tighten.

Where are the opportunities?

• We continue to believe that total return fixed income strategies unconstrained by benchmarks are best positioned to navigate the later stages of the economic and credit cycle. Central banks’ divergent policy paths are creating dispersion in growth and inflation, further increasing the likelihood of market dislocations. Looking through the heightened geopolitical instability, we believe that structural tailwinds — fiscal stimulus, deregulation and robust AI-driven capital investment — keep the backdrop broadly constructive. However, elevated valuations across most sectors suggest that success will hinge on selectivity and discipline.
• Today’s uncertain market environment underscores the growing appeal of an allocation to core fixed income, be it aggregate or credit only. In our opinion, higher-quality fixed income continues to be attractive from both an income and capital-protection perspective, providing a combination of carry and significant potential upside in a risk-off environment. All-in yields remain appealing for investors looking to de-risk or diversify away from domestic government bonds, providing a potentially smoother return profile.
• European investors can seek to embed resilience and enhance income potential through either a bond allocation in local markets or by going global, particularly if they are concerned about the extent of their exposure to the US or USD-denominated assets. Doing so could also potentially provide a yield pick-up, as hedging costs mean USD-denominated investments have lower yields than EUR- or GBP-denominated equivalents.
• We think emerging market debt (EMD) offers potential as both a return driver and a diversifier in fixed income allocations, particularly for European investors. While EMD has historically been more cyclical and volatile than its developed market counterparts, there are reasons to be structurally positive as risks are increasingly originating from developed markets amid disruptive US policy dynamics. Many EM economies also benefit from muted default forecasts, reflecting solid fundamentals across growth, fiscal and external metrics. Despite heightened geopolitical uncertainty, we think select exposure to EMD could still make a positive contribution to a well-diversified portfolio, mainly through carry and USD weakness.
• In our view, high yield remains attractive from an outright yield-to-worst perspective but warrants a cautious approach given market uncertainty and current spread levels. The robust carry may make this a good equity substitute should investors want to de-risk. We advocate an “up-in-quality” issuer bias and careful credit selection but remain cautiously optimistic that this sector can continue to perform well.