Global Fixed Income

Inflation is moderating, but remains slightly above the Fed's target of 2%, supported by easing goods prices, though persistent wage pressures in the service sector pose a problem. US GDP growth is steady at 2.6%, driven by consumer spending and capital investments, however, fiscal deficits and rising public debt pose risks to long-term bond yields. The labour market is softening gradually, with unemployment down at 4.1% in December, while participation rates remain stable. These trends support expectations for more caution around rate cuts from the Fed in 2025.

US Treasuries are trading attractively versus global peers, with real yields near multi-decade highs. On a 10-year Z-score basis, (a Z-score gives you an idea of how far from the mean a data point is), treasuries are undervalued relative to historical norms. Equity Risk Premium (ERP) signals show a relative attractiveness for bonds over stocks on a risk-adjusted basis.

Momentum is unfavorable in both relative and absolute terms, with the more cautious tone on further US rate cuts, political dynamics of the Trump administration and uncertainty around inflation persistence keeping volatility elevated. Conversely, the impact of foreign demand, especially from Japan and Europe, where yields are significantly lower, could bolster demand for US Treasuries as these buyers attempt to lock in yields.

Corporate earnings remain stable, with earnings before interest, taxes, depreciation, and amortization (EBITDA) margins improving slightly for investment-grade issuers. Interest coverage remains robust at 9.3x for higher-rated credits and refinancing risks are muted in the short term due to staggered maturities, with most issuers not exposed to higher rates until 2026 or later.

Investment grade spreads of 84 bps over US treasuries are tight by historical standards, offering limited room for further compression. Relative value opportunities exist in selected industries like energy and infrastructure, where spreads remain wider than pre-pandemic averages.

Strong inflows into investment grade credit funds and ETFs support demand-side dynamics. Reduced issuance in Q4 2024 also helps maintain spread stability. Relative performance versus government bonds remains attractive, particularly for medium duration corporate bonds. However, the absolute performance is weak across most major time frames as compressed spreads are increasing the sensitivity to rising yields.

Earnings resilience in high yield issuers is notable, with revenue and EBITDA growth of 3.2% YoY in Q4 2024, driven by energy and leisure sectors. Defaults remain near historical lows, but are projected to rise modestly in 2025.

High yield spreads of 297 bps over treasuries are tight relative to historical averages (5-year average: 427 bps), limiting return potential. However, the risk premium remains attractive compared to investment grade credit (albeit this has also compressed) and equities. Relative value opportunities exist in selective B-rated issuers within outperforming sectors.

There is strong technical support from robust inflows into high yield ETFs and funds. Year to date issuance trends remain healthy, with investor demand offsetting refinancing pressures. Liquidity conditions are favorable, with secondary market activity robust across most high yield categories. Despite the shorter term weakness in absolute terms, the medium and longer term dynamics are strong, while the relative price actions are firmly favouring high yield over investment grade and government  bonds.