Fixed Income Monthly - August 2025

The Fixed Income Monthly provides a forward-looking summary of the medium-term views from Fidelity’s Fixed Income team. Our investment approach is multi-strategy, with portfolio managers given clear accountability and fiduciary responsibility for all investment decisions in a portfolio. Given this portfolio manager discretion, there may at times be differences between strategies applied and the views presented in this document. We believe in managing portfolios with a mix of active investment strategies, including top-down and bottom-up, such that no single strategy dominates risk.

outlook

Markets continued to exhibit a risk-on style as the US struck trade deals with some key partners, seemingly removing the tail risk that tariffs would cause major disruption in the world economy. This led to a broad rally in credit, with spreads tightening even further. Government bonds lagged performance due to hawkish signals from the ECB and the Fed, as well as ongoing fiscal sustainability concerns.

Throughout July, the US dollar strengthened versus other currencies, but it remains materially cheaper than it was at the start of the year. We continue to be bearish on USD, favouring a basket of EM FX, which screen cheaply in trade-adjusted terms. We have also added GBP to the short leg of this trade, as the currency is back to its pre-Brexit levels in trade-weighted terms, and the UK faces considerable fiscal pressures.

Market optimism around the US economy soured after the US nonfarm payroll (NFP) data was well-below expectations for July, along with significant downward revisions for May and June. We expected negative revisions as these are typically correlated to the strength of the US economy, as reflected in PMI data. But these revisions were the lowest since May 2020, highlighting the underlying weaknesses in the economy.

NFP revisions versus ISM PMIs

One factor that was artificially inflating US economic data in May and June may have been trade front loading before the tariff deadline. This was evident through a number of indicators, one of which being cargo from China to the US, which increased sharply in the months leading up to deadline day. This growth stimulant, along with easing financial conditions from prior rate cuts and a weakening dollar, inflated the figures we were seeing until, ultimately, the hard data disappointed the overly optimistic market.

China shipping cargo to the US (tonnes, 000s)

This benefited our long US duration positioning, and we have largely retained positions here alongside EM local rates and UK gilts. EM locals still present attractively high real yields, where we expect to see more cuts.

On credit, we remain underweight through short positions in CDX High Yield, due to the recent tightening in credit spreads. We think further economic weakness and trade disruption could put additional pressure on credit, where credit spreads are implying continued strong economic growth and no real risk of any slowdown. This is true across the credit spectrum, where high yield and crossover credit spreads are both moving in tandem and are both highly correlated to moves in equity markets.

In inflation, we are long of US 5-year breakevens through inflation swaps. Although US market implied inflation edged higher in July, markets remain relatively relaxed about US inflationary pressure, with 3.4% CPI priced in for the next year, before dropping to 2.5%. There is still great uncertainty around the extent to which tariffs will be inflationary as companies decide on passing on the additional costs to consumers.  While the market implied rate is not far from our base case, a long inflation position acts as a relatively cheap hedge on our directional rates positions.

Outlook

Global IG credit returned 0.25% in July with spreads tightening by 9bps overall. In July, risk assets remained resilient, continuing their grind tighter, with credit spreads in most regions exceeding previous year-to-date tights. Credit spreads continue to seem impervious to a series of headlines and risk events, mainly from the US. Globally, by the end of July, cracks have been starting to show in hard data, with increasing evidence that tariffs are eroding investor confidence and spending ability across geographies.

Our credit positioning continues to be defensive across most IG funds. Spreads are very tight, and in many cases are not offering enough compensation for lingering headline risks and fiscal uncertainty.

IG spreads (bps) continue to return to tights

US IG credit returned 0.15% in July with spreads tightening by 7bps. Trade tensions re-emerged this month with a promise of no further extensions to the 1 August deadline. Market reactions have been muted, with a limited impact on IG spreads, particularly in response to the EU-US deal, which has limited the probability of a disruptive trade war between the world’s two largest trading blocs. We maintain our short credit position as we see limited value at these levels, even in new issue markets.

Hard data prints at the end of July have added increasing weight to our conviction in the weakening US consumer, so we have maintained a slightly long duration position in the funds. We are closely monitoring what appears to be a real income squeeze in the US, where hard data shows wage inflation is falling, but core goods prices are ticking up.

Euro IG credit returned 0.50% in July with spreads tightening by 13bps overall. The fledgling US-EU trade deal and defence relationships are yet to be ratified but appear to have reassured markets, nonetheless. We expect this deal to have reduced the probability of further ECB rate cuts.

European corporate IG credit earnings have been mostly positive in July, but with increasing idiosyncratic negative earnings prints. This risk is not reflected in credit spreads, which remains tight relative to history, leaving minimal upside. We remain underweight credit risk in Euro funds. There continues to be demand from some investors for diverse and flexible allocations.

Sterling IG credit returned 0.31% in July with spreads tightening by 7bps. We are moving towards neutral duration in the funds, in anticipation of a quiet summer. Credit valuations continue to creep tighter, with levels continuing to gloss over geopolitical and fiscal risks.

Uncertainty indices globally are elevated

Asia IG credit returned 1.3% in July with spreads tightening by 3bps. Asian economies remain resilient despite Fed tightening and a strong US dollar. We have moved to a neutral credit position as tight spreads do not adequately compensate for the uncertain macro backdrop. Similarly, we are also seeing demand for Asian IG credit from investors looking to diversify.

Outlook

Global high yield posted positive returns of 0.7% and spreads tightened by 20bps. Some tariff tail-risks were alleviated as the US announced trade deals with the EU, Japan and South Korea. Tariff rates elsewhere are still being negotiated, with current rates varying on a country-by-country basis. Despite a slightly improved risk assessment, we believe that high yield spreads should include an additional premium to account for ongoing macroeconomic uncertainty.

USHY: Limited new issuance for CCCs

US HY posted positive returns of 0.4% and spreads tightened by 10bps, indicating a favourable macroeconomic outlook despite uncertainties from tariffs and global tensions. While Q2 earnings remain stable overall, cyclical sectors such as Autos, Airlines, and Chemicals have seen some profit warnings, in contrast to growth in sectors like Tech and Financials.

Overall, credit fundamentals remain robust, albeit with a slight decline in interest coverage. Fiscal stimulus and expected monetary easing are drawing investors back into credit. The increase in credits yielding below 7% is largely due to spread compression and the inclusion of a number of newly fallen angels.

While the CCC-rated new issue market continues to see limited activity, there is plenty of defensive issuance from stronger credits looking to extend maturity walls and enhance liquidity. Despite looming macroeconomic uncertainties, such as labour market health, Federal Reserve's future actions and the potential for fiscal dominance, we maintain a neutral stance with support from seasonal factors and generally supportive earnings.

EHY fundamentals remain in check

European HY delivered strong positive returns of 1.2% over the month as spreads tightened by 41bps. The EU trade deal with the US, while somewhat controversial, allayed market fears about full-scale trade war. Together with an accommodative ECB, strong technicals and relatively solid fundamentals, the region is sufficiently attractive to investors amid strong performance in HY credit globally.

Overall, our view on European HY remains positive, although we caution against investor complacency in this environment where valuations are rich and macroeconomic factors remain fluid.

The Asia HY market is experiencing compression, with the benchmark returning 1.0% in July. Recently, challenged and weaker names that lagged this trend have started to rally significantly, raising concerns of euphoria due to lack of differentiation against distressed credits.

On the primary front, net supply reflects strong technicals and has driven spreads tighter. We remain cautious in fully committing to risk amid unfavourable risk-reward trade-offs.

Outlook

In July, emerging market debt showed mixed results with hard currency sovereigns outperforming emerging market corporates and local currency bonds as spreads tightened over the month. Local currency denominated bonds were impacted by the stronger US dollar that subtracted from returns. Despite rising macro uncertainties, EM credit markets remain resilient, supported by rating improvements and favourable supply-demand dynamics.

EM sovereign spreads have been resilient

The current market environment is broadly supportive for emerging markets. Notwithstanding the July rally, the weaker US dollar helps emerging market borrowers, while global interest rates do not appear to have significantly hindered issuance for most sovereigns and corporates. Growth outperformance for emerging markets relative to developed market peers might lead to an increase in capital flows into developing nations, especially if investors adjust portfolios away from the US.

We favour countries with lower tariff exposure, such as relatively closed economies in Latin America and those implementing structural reforms, like Argentina and Turkey. We have moved to a neutral stance on emerging market hard currency sovereigns amid the generally supportive environment for credit spreads. As valuations for dollar-denominated bonds are expensive, we focus on relative value opportunities to refine our positions over coming months.

We remain overweight in EM local currency duration, anticipating continued monetary policy easing from some EM central banks. The weaker US dollar and stronger disinflationary impulse, driven by lower oil prices and subdued domestic demand, particularly in emerging Asia, have prompted many central banks to lower interest rates. Monetary easing is expected to broaden by year-end beyond Asia as very high real interest rates supress activity.

Finally, in past cycles, when the US Fed starts to lower the Fed Funds Rate, many EM monetary policy committees found it easier to follow the Fed rather than front-run it.

Stronger US dollar negatively impacted EMFX returns

The rebound for the US dollar came amid a previous build-up of dollar short positions. Carry traders were borrowing greenbacks to fund higher yielding investments across many markets. We see a reduction in such positions in currency markets as a healthy recalibration, given that the size of such trades was growing while volatility was suppressed, potentially creating the conditions of a disorderly unwind.

If the dollar continues to rebound, we look for increased divergence, making market selection for potential outperformance increasingly important. However, despite strong year-to-date returns we do not consider EM currencies overvalued in general and we continue to favour them over the medium-term investment horizon.

• Fixed Income Monthly - July 2025
• Fixed Income Monthly - June 2025
• Fixed Income Monthly - May 2025
• Fixed Income Monthly - April 2025
• Fixed Income Monthly - March 2025
• Fixed Income Monthly - February 2025