The US economy has entered unknown territory in more ways than one. The Trump administration’s policy mix of fiscal loosening, tariffs and severe immigration restrictions are raising a lot of questions among market participants and economists. The Federal Reserve has seen its independence challenged. The current “low fire, low hire” labour market represents a tipping point: will job creation and hiring resume, or are large-scale layoffs looming? These uncertainties have now been compounded by the US government shutdown, which, in addition to its very own effects on the US economy, also leaves investors with less timely and reliable data on which to base their decisions.
In the eurozone, things are much clearer. The ECB has successfully steered the bloc to a “soft landing”, with inflation again under control and growth still positive, albeit weak. This does not mean that the continent doesn’t face its own risks, such as a larger-than-expected tariff shock or geopolitical events.
Credit markets were unperturbed and thanks to steady inflows, risk premia continued to grind tighter. The markets’ risk appetite seems unbroken.
US rates: markets are taking things as they come
Last month, we maintained a positive stance on US duration, targeting yields between 4.0% and 4.2%. As the 10Y closed in on 4%, we took profit and returned to a neutral stance. We are now close to turning positive again and looking to enter long positions on any weakness. Absolute fair value still appears compelling, although we acknowledge that inflation concerns persist.
We are also implementing a steepener on the US curve, however for somewhat different reasons than in the eurozone. The short end should be supported by monetary easing, while the long end is structurally under pressure from high deficits coupled with investor worries about debt sustainability. We elect to implement on the 5-30, which means a lower carry sacrifice than the 2-30.
Markets currently price a terminal rate of 3% for the Federal Reserve and 2% for the European Central Bank, suggesting limited divergence between the two. Despite the relatively modest pace of Fed cuts so far, financial conditions remain very accommodative – at their easiest outside of the COVID period. Recent rate declines have been driven primarily by real rates, while inflation expectations remain elevated. Tariffs are expected to exert upward pressure on goods inflation over the medium term, while inflation on core services excluding housing remains high… a concerning trend. ISM services prices paid also remain high, likely prompting the Fed to adopt a gradual approach to rate cuts. We anticipate two additional cuts this year.
Hard data continues to show resilience, while soft indicators lag. The Citi Economic Surprise Index remains positive, and Atlanta FedNow estimates confirm robust growth. However, labour market signals are less encouraging. The ADP report revealed a 30,000 decline in payrolls, hinting at potential deterioration. Historically, negative payroll growth correlates with economic contraction, though current conditions suggest a “frozen” labour market rather than outright weakness. Volatility in jobless claims further supports this interpretation. The US government shutdown introduces additional downside risk to growth.
Current inflation break-evens are hovering around 2.4%, with the recent uptick in yields coming largely from real rates. We believe that in this environment, purchasing inflation protection is prudent, as we could see nominal yields pricing lower real rates and higher inflation expectations.
Predictability and stability in the eurozone
Economic surprises in the eurozone remain subdued, which no doubt reassures ECB policymakers. Growth remains slow, supported by modest improvements in some sectors. PMIs are hovering just above 50, while manufacturing PMIs drift lower. Tariff risks persist, reinforcing a cautious outlook. Inflation signals remain prudent, with projections below 2% by early 2026. Both headline and core inflation appear stable, justifying a neutral grade. After also having gone neutral on our curve strategies, we are re-implementing our steepening conviction (10-30). Technicals – Dutch pension reforms – are a major driver and we understand that the 2nd and 3rd largest Dutch pension funds are on track to make the move to defined contribution plans in 2026. This will structurally weaken demand for long bonds.
ECB messaging remains unchanged. President Lagarde reiterated confidence in the current policy stance, with minimal rate cuts priced – less than 10 basis points over a one-year horizon.
Flow dynamics should improve towards year-end, supported by reduced issuance in Q4 as most countries near completion of their 2025 funding programmes. This shift supports a positive supply-demand indicator. Positioning remains broadly unchanged, with moderate duration reductions but no significant moves.
Political uncertainty in France has intensified following Prime Minister Lecornu’s resignation. President Macron tasked him with negotiations to form a new government, triggering volatility in French spreads and validating our underweight stance. Short-term widening appears likely, though extreme scenarios are improbable. Potential outcomes include:
- Appointment of a new PM, probably from the left or a technocrat
- Dissolution of the National Assembly
- Macron’s resignation (very low probability in our view)
We do not want to exaggerate the magnitude of potential spread widening we see on France, but we clearly prefer to maintain an underweight stance. Depending on the political situation, a spread widening of 10 bps could persuade us to return to a neutral stance.
Emerging markets offer value
Emerging market debt mirrors corporate credit and continues to attract strong inflows, sustaining last month’s momentum. Despite rich valuations, we are upgrading our view on the hard currency side, turning more positive on both sovereigns and corporates. Spreads remain tight, but relative to US credit, EM assets still offer attractive pickup. All-in yield levels provide a buffer against potential spread widening. Despite the inflows, positioning is not overextended.
Inflows are expected to persist across hard and local currency segments. LatAm markets remain particularly attractive, while Asia offers selective opportunities. EM currencies have underperformed for an extended period, eroding returns. However, a weaker dollar affords central banks room to manage depreciation risks.
We maintain long positions in Hungarian rates and FX. Elevated yields and a hawkish central bank underpin this stance. Inflation is expected to fall below 4%, enabling rate cuts. Political developments could unlock EU funding, mirroring Poland’s experience after the election of Donald Tusk.
We continue to believe in the yen’s potential, but there could be some softness
We maintain a constructive view on the euro relative to the US dollar, supported by several fundamental drivers. In Europe, increased defence spending and Germany’s infrastructure investment plans provide a positive backdrop for growth and fiscal stimulus, reinforcing confidence in the region’s economic outlook. In contrast, the US economy shows signs of moderation, particularly in the labour market, which has prompted a more cautious tone from the Federal Reserve. This shift toward a dovish FOMC stance reduces the relative appeal of the dollar. Current interest rate differentials between the ECB and the Fed also favour the euro, as the gap narrows and policy expectations become less supportive for the USD. Taken together, these factors suggest that the euro retains upside potential versus the US dollar in the near term.
We maintain a short position in GBP due to the UK’s challenging outlook. The government faces difficult fiscal decisions ahead of the Autumn Budget on 26 November, while growth momentum remains weak. Market pricing for the Bank of England appears overly optimistic, with no cuts expected until March–April, which we believe underestimates downside risks.
Conversely, we hold a long position in JPY, supported by expectations that the Bank of Japan will maintain a policy stance favourable to the currency. However, the recent LDP leadership outcome, with Takaichi emerging as a key figure, is seen as less supportive for the yen in the short term, prompting a cautious reassessment of the pace of appreciation.
We go long on AUD, reflecting its relative resilience and leverage to global growth stabilisation. The currency benefits from improving terms of trade and a supportive commodity backdrop, while the Reserve Bank of Australia’s policy stance remains less dovish than peers, providing an additional tailwind.
Credit markets are still expensive, but buffeted by good fundamentals and technicals
From a valuation standpoint, yields remain appealing. The Euro Investment Grade segment currently offers around 3.1%, while Euro High Yield hovers near 5% – levels that provide a meaningful cushion against potential spread widening. These carry levels translate into a solid income floor for portfolios, particularly in a low-volatility environment.
We are upgrading US high yield to neutral, supported by resilient growth, weak employment data and a rate-cutting cycle without a recession – an ideal backdrop for credit. Further tightening potential remains, and we expect spreads to narrow slightly as conditions improve. Our position on EUR HY remains unchanged at neutral.
We continue to take a positive view on EUR IG. EUR-denominated IG offers attractive valuations relative to other IG segments on a risk-adjusted basis. While spreads are also very tight on an absolute basis, the macro backdrop in the eurozone is rather clement. In the short term, limited supply as we head into the earnings season blackout period will also be supportive. We are neutral on USD IG, given the greater uncertainty and the segment’s greater duration and hence higher price volatility for any spread move.
On AT1s/CoCos, we have decided to tactically take profit and return to a neutral stance amid heightened uncertainty. However, we remain attentive to any spread widening that could provide an attractive re-entry point.
