June proved to be a fraught month for market participants—marked not only by record-breaking heatwaves, but also by a barrage of geopolitical and macroeconomic developments that tested investor nerves. Oil prices surged as hostilities involving Israel, the United States and Iran intensified, raising the spectre of regional destabilisation amid talk of regime change. Although tensions in the Middle East gradually de-escalated, investor focus shifted to the looming expiration of the 90-day pause announced by President Trump following “Liberation Day.” The erratic oscillation between escalation and détente underscored the precariousness of policy shaped at the President’s discretion.
In Europe, NATO's pledge to allocate 5% of GDP to defence by 2035 rekindled scrutiny of sovereign debt sustainability, casting a spotlight on asset-swap spreads and term premia. Meanwhile, across the Atlantic, the so-called “Big Beautiful Bill” carries similarly weighty fiscal implications. The European Central Bank (ECB) cut its key policy rates by 25 basis points in June, bolstered by declining inflation figures and projections underpinned by weaker energy prices and a strengthening euro. Nonetheless, downside risks to both growth and inflation persist, primarily due to the global repercussions of US trade policy. That said, rising government expenditure on defence and infrastructure is expected to provide medium-term support to growth.
In the US, the Federal Reserve held rates steady, though its median projections continue to suggest two cuts before year-end. Chair Jerome Powell admitted that without the tariff-induced uncertainty, easing would likely have already occurred. Despite widespread belief that President Trump’s ad hoc use of tariffs as a bargaining tool has already begun to dent economic sentiment, hard data has yet to confirm substantial damage.
While these developments contributed to market volatility, fixed income markets delivered a positive performance. US Treasury yields declined in June, buoyed by softening macroeconomic indicators and signs of labour market weakness—both of which strengthened the case for Fed easing. Early July saw yields rise modestly as inflation and tariff concerns resurfaced, with the temporary suspension of tariffs expected to end soon. In Europe, rate markets remained largely steady through most of June before edging higher into July, as investors began to anticipate an end to the ECB’s easing cycle.
Remarkably, cash credit markets demonstrated considerable resilience in the face of uncertainty. Investor appetite for credit remained robust, with technical factors causing spreads to tighten as the market largely adopted a wait-and-see approach to developments in Iran. Strong corporate fundamentals continued to provide a firm foundation for spreads, while steady demand supported performance in the secondary market—even in the face of elevated primary issuance. Both investment-grade and high-yield segments posted positive returns, underpinned by favourable technicals that appear poised to persist amid muted issuance and strong inflows.
In the short term, we are adopting a more neutral stance on US rates, reflecting the complex interplay between recent data surprises and underlying economic trends. The latest nonfarm payrolls headline figure, while superficially strong, masks weaker internal dynamics—such as limited breadth in job creation and a temporary boost from government hiring, possibly distorted by seasonal factors in the education sector. These nuances have tempered expectations for imminent Federal Reserve action, pushing rate cut expectations out by several months. The “Big Beautiful Bill” and broader fiscal concerns have weighed more heavily on the long end of the curve. The Fed appears willing to wait for greater clarity, particularly as recent data has postponed the urgency for immediate cuts. In this context, and following a good performance of US rates, we believe that taking profit on our current long position is appropriate.
However, the medium-term outlook tilts more positively for US Treasuries, underpinned by a projected slowdown in economic activity and persistent trade policy uncertainty. Market moves over the past month have largely been driven by declines in real yields, while inflation expectations (break-evens) have remained stable—signalling investor concern about future growth rather than inflation. While financial conditions remain easy and inflation is expected to trend higher, the Fed’s focus also remains on the labour market. The broader labour market appears to be gradually weakening, with softening indicators in both the manufacturing and services employment components of the ISM surveys, as well as a deterioration in labour confidence metrics. With leading indicators signalling further softening ahead, the medium-term view remains constructive on duration, favouring positioning on the short end rather than the long end.
After a period of constructive positioning, we have moved to a more cautious stance on eurozone duration. This recalibration, initiated in late June, reflects a confluence of factors that collectively call for prudence, even as core rates hover near fair value. On the short end, two-year yields remain attractive from a valuation standpoint. However, the 10-year segment, with fair value estimated at around 2.5%, offers only marginal long signals, placing the market close to equilibrium.
Macroeconomic fundamentals offer little impetus for a strong directional view. Business cycle indicators continue to paint a sluggish picture. While PMIs have nominally improved, they remain tepid—hovering around 50, with countries like France still coming in below this threshold. The broader growth outlook is one of stagnation rather than momentum, with marginal gains suggesting output only slightly above zero.
Inflation dynamics are also stabilising. Headline CPI has crept back towards 2%, and core inflation is expected to remain around 2.3% in the near term. A further decline is not anticipated until 2026. This relative anchoring has led to a neutral signal on inflation and monetary policy, especially as market pricing aligns with expectations for one more ECB cut this year (with the latest ECB meeting revealing that the central bank is nearing the end of its easing cycle).
From a supply perspective, the second half of 2025 should see reduced issuance pressure, following significant front-loading earlier in the year. German bond supply, in particular, has been well absorbed, with strong bid-to-cover ratios and rising non-resident interest. However, medium-term supply concerns are more pronounced, particularly post-2026, driven by expanding fiscal plans and increasing reliance on long-end issuance. These dynamics underpin a continued conviction in 10s30s steepening strategies, especially in Germany and the Netherlands, where structural shifts (such as Dutch pension fund transitions) add steepening pressure.
Positioning across sovereigns reveals selective risk-taking in non-core markets. Recent trades include exposure to Slovenia’s sustainability-linked bonds and sub-sovereign paper like Flanders over Belgium, offering both yield pickup and better fiscal metrics. Overall, the bias is one of defensiveness on duration, with opportunistic engagement in relative value and steepening trades as macro and supply stories evolve.
Both Euro and US investment grade (IG) credit markets are demonstrating remarkable resilience against a backdrop of geopolitical uncertainty and macroeconomic noise.
Despite limited potential for spread compression in the coming weeks, robust fundamentals remain a pillar of support. Ratings momentum in Euro IG remains positive, with more upgrades than downgrades, and Q1 earnings were stable. While Q2 results—particularly from banks—are being monitored closely, no material deterioration is anticipated. Technicals also offer support: a burst of front-loaded issuance in May and June has largely satisfied market supply, setting the stage for subdued issuance through the summer. Strong demand, manageable positioning and reinvestment flows further reinforce the constructive tone. However, with spreads at such tight levels, we continue to hold a neutral position going into the summer.
Within this landscape, higher-beta segments such as AT1 CoCos are seeing renewed interest, driven by 6% yields, contained supply and healthy demand absorption. While spreads are tight and summer volatility remains a risk, the compelling carry and sound credit backdrop justify a modestly positive stance on the asset class
In the US, investment grade credit mirrors this narrative. Although valuations are similarly stretched, fundamentals are in decent shape —EBITDA margins are expanding, leverage is declining, and large IG names maintain healthy revenue and manageable interest burdens. Sector divergence exists, with energy and chemicals lagging, but strength in tech and healthcare balances the equation. These dynamics support a continued neutral outlook on US IG, underpinned by broad-based corporate stability.
In the high yield space, the narrative is one of selective optimism—particularly in Europe—tempered by deteriorating fundamentals and stretched valuations, especially in the US market. Unlike the investment grade sector, the rating drift for HY is decidedly negative across both regions, reflecting rising default pressures, particularly among lower-rated issuers. Sectors such as auto and retail are under stress, and so-called “zombie” companies—those unable to service debt amid higher interest rates—are increasingly edging toward restructuring or default.
Nonetheless, the Euro HY market is showing signs of technical strength. Inflows have returned to positive territory, underpinned by more attractive valuations following a supply-driven underperformance in June. With primary issuance expected to slow through the summer, European HY spreads, while rich relative to long-term fair value, could remain stable if volatility remains contained. Additionally, the relative cost of hedging favours European over US high yield, enhancing its appeal to global investors.
Dividend recapitalisations remain a concern, however, as private equity-backed firms resort to large payouts amid sluggish IPO markets—adding further pressure to credit metrics. Still, the overall environment is seen as supportive enough to warrant a move back to a neutral stance on Euro HY, driven by strong demand and easing supply.
In contrast, US HY remains under pressure. Fundamentals are deteriorating, valuations are deemed excessively rich, and technicals are beginning to weaken as the post-earnings blackout lifts and issuance resumes. Recent large deals, such as Carnival’s, exemplify this renewed supply dynamic. Given this backdrop, the stance on US HY remains firmly negative, with little near-term upside amid tightening financial conditions and an increasingly crowded valuation landscape.
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