We maintain a neutral stance on US duration. Market dynamics continue to be dominated by geopolitical developments and the evolution of the conflict in the Middle East, primarily via its impact on oil prices. In this environment, strong directional positioning appears premature.
Despite elevated energy volatility, US rates have been less reactive than European markets. Even at the peak in oil prices, near $120, the US curve continued to price cuts of roughly 50 bps this year, while the eurozone moved towards pricing hikes. The US remains priced close to a neutral monetary policy setting one year forward.
From a macro perspective, the underlying backdrop remains relatively resilient. Economic surprises have diverged somewhat from Treasury moves, potentially reflecting debates around Fed independence rather than deteriorating fundamentals. The labour market appears broadly stable: when netting recent upside and downside payroll surprises, the picture looks balanced. ISM services have stabilised and forward-looking indicators remain consistent with moderate expansion.
Inflation dynamics are more nuanced. Should oil remain sustainably elevated, headline inflation would rise mechanically and second-round effects could begin to influence core measures. Importantly, after several years of above-target inflation, central banks are likely to be more sensitive to renewed headline pressure and less inclined to dismiss it as purely transitory.
We remain long US inflation exposure, though performance has been somewhat disappointing relative to expectations. The US inflation curve is now broadly flat around 2.5% across tenors. Part of the muted reaction may reflect pre-existing structural long positioning and the US economy’s greater sensitivity to potential disinflationary effects from AI. Nonetheless, inflation exposure continues to offer asymmetric hedging characteristics in a sustained energy shock scenario.
We cut our long duration exposure at the beginning of March, following the strikes on Iran—alongside our steepening position. We also closed our long position on Spain, although our medium-term view remains constructive. The evolving conflict introduces potential pressure on non-core spreads, warranting a more cautious stance in the near term, certainly given the strong performance we have already seen.
Recent market moves have been significant and fast-moving. We observed a marked bear flattening, with 10-year and other maturities repricing higher, alongside widening in selected non-core spreads. Volatility remains elevated, and reversals can occur rapidly.
With rates reaching the 2.95% mark on Thursday, we decided to reinitiate a long duration bias. While the initial correction in rates was driven by higher energy prices amid the Middle East conflict, more recently the sell-off was primarily fuelled by shifting expectations regarding the ECB’s reaction function. Comments from ECB members Nagel, Kazimir and Schnabel (widely perceived as hawkish) prompted a further increase in rate hike expectations, with nearly two hikes priced in. We remain prudent on the short end of the curve that could price further adverse scenarios, but at current levels, we felt comfortable adding duration further out the curve.
At the same time, we prefer to remain prudent on non-core spreads, which may face additional short-term pressure.
Eurozone inflation markets have reacted sharply to the conflict. The two-year inflation swap has moved in near-perfect correlation with oil and gas prices, and summer year-on-year inflation fixings are now pricing above 2.5%. Strong buying flows into euro linkers reflect the unwinding of prior expectations of inflation undershooting in 2026, explaining the relative outperformance of eurozone inflation markets versus their US counterparts.
We remain positive on UK rates. Market pricing currently indicates a higher probability of hiking than easing. While a sustained gas price shock would complicate the outlook, the underlying UK labour market appears materially weaker than in the eurozone, limiting the Bank of England’s ability to pivot aggressively towards hikes.
Underlying inflation had already been trending lower prior to the conflict. In a stabilisation scenario, the asymmetry remains favourable for UK duration.
Emerging markets experienced a near “perfect storm”: higher core yields, stronger USD, elevated volatility and rising oil prices. Despite this, hard currency sovereign spreads widened only modestly (approx. 20 bps), insufficient to constitute a compelling buying opportunity.
We therefore move back to neutral on EM local currency and EM corporates.
On hard currency, spreads remain tight and technicals are not yet sufficiently supportive. Inflows into local currency markets have remained positive, even in March, and real rate differentials versus the US remain attractive in select markets (notably Brazil and Mexico).
In portfolios, we adjusted funding for long exposure to EM currencies (reducing USD funding in favour of EUR) in order to mitigate dollar-driven volatility while maintaining selective local currency exposure.
We return to neutral on the US dollar. The dollar is again playing its role as a safe haven and hedge for risk assets.
We also maintain our long JPY position. The yen continues to screen attractively on valuation metrics, and the probability of further Bank of Japan normalisation supports medium-term appreciation. Political uncertainty has diminished following the recent election outcome, and the risk of official sensitivity to excessive currency weakness remains present. We are prepared to tolerate short-term volatility in exchange for medium-term asymmetry.
We remain short GBP, reflecting both political uncertainty and a marginally more dovish Bank of England stance than currently priced. While we retain constructive exposure to UK rates, the currency faces a less favourable risk-reward profile, particularly if fiscal or political dynamics reintroduce risk premia.
This month, we have rotated selectively within other G10:
Spreads have widened only modestly in both investment grade and high yield, despite rising risks. We therefore move to neutral on EUR IG (EUR) and increase our underweight on High Yield globally. We also move to a cautious view on USD IG.
High yield fundamentals are clearly deteriorating from a fundamental perspective, and this is reflected in ratings actions where downgrades are increasing relative to upgrades. Several sectors face structural disruption (software, autos, beverages). Valuations remain tight, and technicals, previously supportive, are turning less favourable, with outflows emerging in leveraged loans, private credit and increasingly in public high yield. At the same time, supply is expected to increase, potentially as private credit issuance migrates toward public markets if private credit GPs are unable to raise fresh capital. Historically, these have tended to be weaker issuers.
In contrast, investment grade fundamentals remain robust. Large issuers retain balance sheet strength and demand remains resilient in most sectors, including tech, despite volatility. In IG, our strategy is to buy meaningful spread widening opportunistically.
In convertible debt, we also move from an overweight to a neutral stance on the asset class overall, but we remain more optimistic around lower-delta convertibles. Three of the four key drivers of convertible performance (equities, rates, credit) have been negative recently, with only volatility making a marginally positive contribution. Valuations across the convertible universe are broadly neutral, but dispersion is significant. Low-delta convertibles appear relatively better valued and remain the core of our defensive positioning. However, given geopolitical uncertainty and equity volatility, we downgrade the overall asset class to neutral.
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