On rates markets, August and the first week of September were marked by a noticeable de-correlation on both sides of the Atlantic. While Euro rates moved sideways, Treasury yields declined significantly, especially at the short end of the curve. This shift and steepening of the curve reflects a weakening labour market, accelerating Fed rate cut expectations. The attacks of the Trump administration against the Fed, pushing for a lower policy rate, probably amplified this movement. Conversely, at the very long end of the Treasury curve, the 30Y yield has moved far less, remaining anchored by long-term nominal growth expectations – both real GDP growth and inflation. Whatever the wishes of the administration, in the absence of direct yield curve control or a recession, long-term rates will probably prove resistant to monetary policy.
In the eurozone, given the calm on rates markets, it’s fair to say that the ECB has successfully engineered a “soft landing”. Despite regional variation, overall GDP growth is still positive, the labour market has not suffered, and inflation is back on target. Political uncertainty in several countries, the ongoing war in Ukraine and the trade conflict with the USA have arguably overshadowed this successful policymaking outcome. Markets are now deciding whether to call the end of the cutting cycle, with the policy rate at 2%. This level still gives the ECB some scope to cut if activity slows more than expected under the tariff shock. Nonetheless, we are now at a point where some economists are already expecting the first rate hikes again towards the end of next year.
Spread asset classes – whether investment grade or high yield, whether credit or sovereign EM, whether USD or EUR denominated – are all telling much the same story, with risk premia falling throughout August with a slight September uptick. In our view, this shows that performance in these asset classes is currently undeniably primarily flow-driven. Clearly, the overall macro environment is relatively benign for all of these asset classes, with global growth still present and a more favourable rates environment. That said, the almost parallel moves in spreads between these asset classes are not totally justified, in our view. In particular, we see divergence in terms of the direction of travel between high yield issuers and investment grade issuers. While the investment grade space is still seeing improvement in overall credit metrics, the reverse is true in high yield. In other words, the two segments are moving farther apart from each other. Lower rates and the continued unbroken appetite for credit has likely encouraged some issuers to adopt more shareholder-friendly behaviours at the expense of creditors: more dividends, buybacks and M&A activity.
In our view, the probability of a marked slowdown in the US economy is rising sharply. The labour market is deteriorating quickly, with payroll data showing significant downward revisions. While some indicators, such as the Atlanta Fed GDPNow estimate and certain ISM indices, still point to resilience, the broader trend is one of weakening momentum. The slowdown is currently concentrated in hiring rather than layoffs, but history tells us layoffs often follow quickly once hiring stalls. If payroll growth continues to stagnate, domestic demand could weaken further.
The US retains a positive grade in our framework, but the risk‑reward balance is becoming more nuanced. Treasuries have already outperformed, and we are now looking for a good level to take profit on our long position, but this will remain in place as long as momentum remains favourable. We continue to prefer shorter‑duration Treasuries, reflecting both valuation considerations and policy uncertainty.
In an alternative scenario where growth remains strong, we would expect long‑term interest rates to rise from current levels. However, our base case now reflects a softer trajectory. The Federal Reserve has pivoted to a more dovish stance, with Chair Powell acknowledging that the balance of risks has shifted. Markets are pricing in three rate cuts this year, with the terminal rate projected around 3%. We believe this leaves some room for further declines in yields, particularly relative to other developed markets.
We acknowledge that inflation remains a concern. Tariffs should push CPI higher in the coming months. While recent data show inflation rising less than feared, historical correlations with ISM Services Prices Paid suggest further increases are possible. Firms may have also been willing to take some margin hits immediately after the implementation of tariffs, preferring to protect market share and being reluctant to be the “first mover” on price increases. The Fed appears willing to cut rates despite easy financial conditions, which raises questions about its independence and policy framework.
We maintain a positive grade on the UK, but the picture is mixed. The Bank of England cut rates again in August, with only a narrow majority in favour. UK consumers remain notably weaker than those in other regions, reflecting both structural and cyclical headwinds.
Market pricing for further rate cuts is limited compared to the US, making the UK an outlier. This divergence stems partly from the acceleration of rate cut expectations in the US, which has not been mirrored in UK markets. In some portfolios, we hold long‑duration positions; in others, we remain short sterling.
Fiscal and economic challenges continue to weigh on sentiment toward the UK. The combination of subdued consumer activity, limited monetary easing and broader global uncertainties suggests the UK will remain a relative underperformer in growth terms, even if gilt yields remain supported by global rate trends.
Our central scenario for the eurozone remains one of low growth, avoiding outright recession but with a non-negligible probability of one occurring. Domestic demand is decelerating, and while recent PMI data show some improvement, the overall environment remains subdued. Tariffs are likely to have a negative impact, though German investment plans could provide some offset.
We expect the European Central Bank to keep the deposit rate at 2% until at least December. Inflation is slightly above 2%, but should fall below that level in early 2026. The probability of a further deceleration in inflation remains high, and the ECB is unlikely to act before its next staff forecast in December unless the economic outlook changes materially. Overall, we think that eurozone rates are broadly fairly valued and see few catalysts that would trigger a substantial parallel shift. We therefore currently prefer implementing our active views on the curve and on a country-by-country basis.
From a curve perspective, we still hold a 10-30 steepener, supported by Dutch pension reforms and increased German supply. Dutch investors currently account for a disproportionately large share of bond buyers compared to their share of eurozone GDP, which substantially magnifies the impact of the shift. Specifically, the move from defined-benefit to defined-contribution schemes allows pension schemes to move away from long-dated bonds, which they previously needed to hold in substantial amounts to satisfy actuarial asset-liability matching requirements.
In terms of our country preferences, we remain overweight on Spain, Bulgaria and Slovenia, while approaching France with caution. France remains a clear weak spot, with PMIs below 50 and political uncertainty following the loss of a confidence vote by Prime Minister Bayrou. We expect President Macron to appoint a new prime minister with a less ambitious fiscal policy agenda. This instability increases the risk of a sovereign downgrade and could lead to further widening of OAT spreads, currently around 75 basis points. The French budgetary situation is challenging, with the first draft of the 2026 budget due on 8 October. Failure to pass a new budget would result in the automatic renewal of the 2025 budget, which would in fact not be catastrophic, leading to some automatic budgetary cuts to kick in.
Emerging market assets have delivered strong performance year‑to‑date, with local currency debt in particular benefiting from US dollar weakness and supportive global financial conditions. The Federal Reserve’s easing bias and the decline in US Treasury yields have provided a favourable backdrop, helping to cushion emerging markets against potential spread widening.
In local currency debt, we have seen strong absolute returns, even though spreads to US Treasuries have widened slightly in recent months. The weakness of the dollar, high real yields in many emerging economies and the fact that most EM central banks—excluding China and Emerging Europe—still have ample room to cut interest rates all support our constructive stance. Technical factors are also favourable, with robust inflows from investors seeking both yield and currency exposure. The main risk to this asset class remains currency volatility, particularly in markets with weaker external balances or heightened political uncertainty.
Hard currency debt has also performed well, but spreads have tightened significantly and now sit at historically low levels. While hard currency bonds still offer a modest yield pickup compared to US corporate credit, the advantage is now broadly in line with historical norms, which limits the scope for further spread compression. Inflows into hard currency debt remain positive, but valuations constrain upside potential. The tightness of spreads leaves little cushion against idiosyncratic shocks or a reversal in global risk sentiment, making selectivity and credit quality assessment especially important.
EM FX has performed well, supported by positive global risk sentiment, high carry and favourable interest rate differentials. We see the most attractive opportunities in currencies backed by strong fundamentals and supportive policy environments, while avoiding those vulnerable to political instability or external imbalances. The interplay between EMFX and local currency debt remains a key consideration, as currency performance can significantly enhance—or erode—total returns in the local debt space.
Developed market foreign exchange markets have been shaped in recent weeks by diverging monetary policy paths and shifting risk sentiment. The US dollar has been slightly weaker overall, although the selling pressure that dominated earlier in the year eased during the summer. The interest rate spread between the euro and the US dollar has once again become a meaningful driver of exchange rates. The pace of US rate cuts will be the key determinant in medium-term performance. It’s important to note that the Trump administration, which appears to be exercising increasing influence over the Fed, has a clear and stated preference for a weaker dollar. Therefore, we can’t expect any policy support to prop up the greenback.
We continue to like JPY in long positions against the dollar. The yen’s correlation with interest rate differentials supports this view and also serves as a defensive, risk‑off hedge with limited downside. We also favour the Norwegian Krone against both the euro and sterling. Norges Bank’s surprise rate cut in June initially weakened the krone excessively, but subsequent economic resilience suggests the central bank will proceed cautiously from here, potentially supporting the currency. In contrast, we are bearish on GBP due to the UK’s fiscal and economic challenges. The pound remains sensitive to domestic political developments and relative interest rate expectations.
Recent volatility in credit spreads, particularly linked to political uncertainty in France, has created selective buying opportunities. In euro investment grade (EUR IG), we have taken advantage of the slight spread widening, prompting an upgrade in our view on the asset class. Fundamentals remain supportive, with more upgrades than downgrades across Europe and no major credit events. Supply has been high, particularly in August – driven in part by “Reverse Yankee” issuance, i.e. US companies tapping Euro bonds markets – but strong inflows have absorbed it well.
In contrast, US investment grade appears less compelling. Valuations are expensive, with long‑term fair value estimates well above current spreads. While fundamentals are still solid, the lack of significant spread widening limits opportunities to add exposure. Tax cuts may provide some support to issuers, but EUR IG remains our preferred market due to better valuations (in light of better fundamentals) and the carry sacrifice that comes with hedging USD credit to EUR.
In high yield, our approach mirrors that of IG. We have upgraded EUR HY to neutral, and also upgraded US HY while holding a slightly negative view. The Fed’s dovish pivot, including in sectors most affected by tariffs such as retail and autos, supports a more constructive stance. However, we also see signs of less credit‑friendly behaviour, including increased M&A activity, excessive dividends and a deterioration in ratings trends. Selectivity is key, with a focus on issuers with solid fundamentals.
We also upgrade the EUR convertible market to neutral, and we would be looking to buy any dips on equity market weakness. Convertible bonds have outperformed equities year-to-date, supported by strong performance of underlying stocks and consistent inflows, particularly into EUR-denominated issues. Valuations show opportunities in convertibles with low delta profiles, i.e. low equity sensitivity and trading closer to the “bond floor”.
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