Having had one of the strongest starts to the year in recent history, fixed income investors saw their returns diminish again in February as government bond yields rose markedly. Corporate bonds, however, held up better with USD credit spreads widening and EUR spreads slightly tightening despite much more hawkish central bank expectations.
In the US, investors are now seeing a terminal rate of 5.6% while the ECB is expected to reach 4.0% at the time of writing. While tighter financial conditions are negatively affecting asset prices, the improving macroeconomic picture seems to offset those for the moment. In Europe especially, investors appear to be comfortable amid very attractive all-in yields, corporate earnings holding up well, sentiment improving and a more benign energy situation. While we find investment grade credit to be one of the most attractive asset classes in the current environment, we still see risks ahead that could stem from increased risk aversion. Looking at recent data, it seems clear that financial conditions need to become tighter, and growth needs to slow further for inflation to get back to the central banks’ 2% target.