- Investment Director
Switzerland, Institutional
ChangeThe views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Welcome to the April 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
- Market volatility surged in response to the 2 April US tariffs announcement as rates exceeded most estimates, with global bond markets rallying at the front end but yield curves diverging significantly at the back end. In addition to equities and spread sectors, US Treasuries meaningfully sold off, while long-dated German bunds rallied as investors searched for a safe haven. Most fixed income markets recovered their losses by month-end, following a 90-day suspension of tariffs beyond the 10% baseline rate and optimism about the potential to negotiate trade deals.
- In the week of the tariff announcement, investment-grade credit markets experienced their largest three-day move since the US regional banking crisis in March 2023. The news of a pause in reciprocal tariffs gave the market some respite, with a subsequent relief rally in spreads. However, uncertainty appears likely to persist. Differentiation between sectors and quality is likely to continue to increase, and investment-grade spreads could move wider as uncertainty weighs on risk appetite.
- Data from the Japanese Ministry of Finance in April showed the largest net inflows into Japanese bonds and equities on record, of US$95 billion in a single month. Around 80% appears to have been into Japanese bonds, with the remainder into equities. While one month from a single market doesn’t necessarily mark a trend, the remarkable size of the flows could signal that foreign investors are reappraising what US markets offer in terms of growth, currency-hedged yields and even safety.
What are we watching?
- Trade negotiations. As of this writing, there appears to be little progress on negotiating lower tariffs between the US and most of its trading partners, although a first trade deal has been announced with the UK. While limited in scope, it reduces tariffs on autos from 27.5% to the baseline of 10% and exempts steel and aluminium. The Trump administration seems intent on keeping the highest tariff rates on China while close trading partners such as Mexico and Canada are likely to secure betters deals. We will monitor developments closely between now and the 90-day deadline on 9 July but we expect most rates to settle well below those first posed given the otherwise severe damage to trading relationships, global growth and financial conditions, not to mention US borrowing costs.
- Fed independence questioned. On 17 April, President Trump posted to Truth Social that Fed Chair Powell’s “termination cannot come fast enough”, and an intra-month sell-off in equities and longer-term US Treasury yields followed. Subsequently, on 22 April, Trump stated that he had “no intention” of firing Powell, precipitating a nine-day rally in stocks. Chair Powell has stressed that the Fed will continue to conduct monetary policy independent of any political pressure and that he will serve out his term until May 2026. Any attempt to fire Powell would likely face legal challenges and roil markets given the sanctity of Fed independence. We would also expect US Treasury yields to rise and the dollar to decline as investors would likely demand more compensation for the uncertainty and inflation volatility that would ensue from compromised monetary policy.
- The smile theory – from USD to JPY? According to former IMF economist Stephen Li’s US dollar “smile” theory, the dollar tends to strengthen when the US economy is very strong (due to increased investment in US assets) or very weak (given the dollar’s reserve currency status) – producing a "smile" shape when plotting the dollar’s strength under different economic conditions. While capital flows into US assets have kept the US dollar “smiling”, this could fade due to a reversal of US exceptionalism, supportive fiscal policy outside the US and competitive investment alternatives, such as AAA-rated sovereign debt in Australia and New Zealand. If flows are diverted, the dollar could depreciate and an alternative, the Japanese yen, could start to beam. The yen has long been considered a safe-haven currency benefiting from the left-hand side of the “smile”, as Japan holds a large net international investment position, which can be repatriated in times of financial and/or economic stress. It is also a low-yielding market that benefits from carry trade unwinds in times of deleveraging. The Bank of Japan’s (BoJ’s) extraordinarily loose monetary policy has created a large rate gap between Japan and the rest of the world, but if trade uncertainty declines and the BoJ hikes rates to normalise policy, we could see a stronger yen representing the other side of the “smile”: a stronger economic outlook leading to currency appreciation without giving up safe-haven properties.
- India/Pakistan escalation. On 22 April, a terrorist attacked killed tourists at Pahlagam, in the Indian-administered portion of Jammu and Kashmir. Since the attack, the militaries of India and Pakistan have exchanged fire across the Line of Control in the region, with Pakistan expecting a retaliatory attack by the Indian armed forces. In the meantime, the Indian government has suspended the Indus Water Treaty, referring to the waterway that provides much of Pakistan’s water. Conflict between two regional, nuclear-armed powers is cause for substantial concern.
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 an increasingly 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 de-risk within a broadly diversified portfolio. 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 the normalising of default rates relative to current spreads. At the same time, the robust additional income potential may make high yield a good equity substitute. For all higher-yielding credit, we believe an “up-in-quality” issuer bias is warranted.
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