After the hit to risky assets and even US Treasury bonds in the wake of the so-called “Liberation Day” announcement of a far higher tariff regime, some semblance of calm returned to markets. Treasury bonds gave back much of their losses and credit risk premia subsided as well, without quite returning to the levels of end of March. The US dollar did not recover, but stabilised after having lost some 4% against a global basket of currencies around mid-April. A slight softening in the administration’s rhetoric, a perceived increase in the relative importance of Treasury Secretary Bessent in the cabinet, the announcement of substantial exceptions to the new tariff regime and hopes for country-by-country deals were the main factors that led investors to become buyers again. However, policy uncertainty remains extraordinarily high in historic terms, putting consumers and firms in a very difficult position. Every additional month of foregone and postponed investment decisions will hurt the growth prospects of the US economy.
Euro-denominated assets have benefitted from the rotation out of dollar assets, but this is clearly a very relative preference. The outlook for the Eurozone economy is undoubtedly cloudy and indeed increasingly so, being as it is at the centre of global trade. This leads us to still hold a constructive view on Eurozone duration and careful positioning on credit risk.
The US 10-year gave back the losses sustained at the beginning of the month and ended April at nearly the same level as end of March. Tariffs can be expected to have a clearly negative effect on US growth. While the potential impact on inflation is more difficult to gauge, demand destruction could potentially be more potent than the immediate effect of price increases. As we have already seen some weakness in soft data and investors are braced for this to follow through into hard data as well, a risk to a long position is positive surprises in economic prints. To some extent, we saw this play out in the ISM Manufacturing beat. We also note that contrary to what we observed in the first quarter, both components of the 10Y – real yields and breakevens – have been moving together recently, indicating increased worries of a recessionary scenario. Ultimately, yields are still at elevated levels compared to where the “neutral” rate probably stands and there is likely still room for the terminal rate as priced by markets to fall further.
The month of April sent a clear message to investors that a “Trump put” no longer exists for equity markets, but does indeed seem to be in place for the Treasury market. Lower yields appear to be a priority for the administration. Confused rhetoric notwithstanding, there are levers that the Treasury can use to put downward pressure on the 10Y, even if that comes at the expense of accepting higher yields at other tenors.
It bears reminding, however, that Euro-based investors should not look at the movement of US yields in isolation. We are negative on the prospects for the dollar compared to the EUR, and the substantial short-term rate differential increases the yield sacrifice investors need to accept for currency hedging. The 10Y US Treasury hedged to EUR gives a significantly lower yield than a German 10Y bond.
Core Eurozone government bonds have now essentially given back the substantial rise in yields that we saw after the announcement of the German government to invest nearly 1,000 billion in infrastructure and defence. The growth outlook for Europe is weak and indeed has weakened further, and fiscal support will not show a material effect until 2026. The inflation outlook, on the other hand, should be less supportive for rates going forward. While we don’t expect reflation, disinflation has now already progressed substantially and there is simply less room for further progress. Lagarde sounded dovish at the April meeting both on the growth and inflation front, leaving monetary policy a supportive factor. In the short term, we also expect technicals to be supportive. National treasury agencies have already covered an over proportional amount of their yearly funding needs year-to-date while net supply is also less detrimental in May, and sentiment should also continue to be supportive.
The good performance over the past weeks however leads us to become slightly less positive overall as we move closer to fair values.
On a country-by-country basis, we still prefer Spain and are underweight France. Spreads over Bunds trade at similar levels for these countries, while Spain benefits from significantly stronger growth and probably political stability.
We remain prudent in terms of our Euro credit exposure. The impact of tariffs and potential negotiation outcomes remain uncertain. We have seen spreads tighten again somewhat as there has been a pause in the trade war rhetoric, but we do expect to see greater impact on firms and consumers going forward. In this earnings season, firms are stressing the lack of clear visibility, and in some cases dropping forward guidance altogether. We do still have a relative preference for subordinated financials compared to High Yield due to the lower exposure to global trade conditions.
Recently, US firms are also increasingly tapping Euro bond markets, likely to take advantage of lower borrowing costs. It remains to be seen if this trend persists and requires observation in terms of the risks and opportunities that exposure to firms with primarily US-based activities in a EUR credit portfolio can bring.
We also move to take a more negative stance on US credit relative to EUR credit. Despite Europe’s high sensitivity to global trade conditions, we are less comfortable with the level of risk priced into US credit. Risk premia in investment grade are at nearly identical levels to EUR, while recessionary risks are a clear danger. Regarding the HY segment in particular, we can expect to see additional stress from three “blue chip” firms at the risk of a downgrade: Ford, Boeing, and Warner. This could strain market liquidity and amplify selling pressure. Although this would mean major “blue chip” corporates entering the HY universe, perhaps in fact boosting its average liquidity and quality – we do not think that the increased size of the market would be offset by a corresponding increase in appetite for HY debt. This could significantly tip the balance towards too little demand for too much supply, especially because many current holders of these potentially downgraded issuers will be forced to sell – which will also “crowd out” demand for other issuers.
April was an eventful month for currency markets, marked above all by strong underperformance of the USD. The Euro was in fact one of the strongest G10 currencies, only beaten (very narrowly) by the Yen and by a somewhat larger margin by the Swiss Franc.
We go short on the USD vs. EUR. We see the end of “US exceptionalism”, a loss of confidence in US assets, a slowing of the US economy and the German infrastructure and defence package as drivers of a stronger Euro. We additionally implement a EUR long vs CAD; due to the continuing high sensitivity of CAD to economic weakness in the US, exacerbated by the trade war and lower oil prices.
Additionally, we also implement a short CHF vs. JPY, as a trade that is relatively insensitive to overall moves in risk sentiment. The Yen could also benefit from a potential deal rumoured to be under negotiation with the Trump administration.
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