Fixed Income Monthly - September 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

This year we have faced almost daily challenges from sovereign bond wobbles, geopolitical crises, tariff uncertainty, and ongoing conflicts around the world. And yet, markets are generally back to where they were at the start of the year. We are continuing to see implied volatility collapsing across, rates, FX, credit and equity markets, with rates volatility back to its comfortable pre-Ukraine war levels.

With markets largely ‘priced for perfection’, we are looking at the apparent disconnect in US inflation markets. Outside of inflation swap markets themselves, there is a broad assumption that inflation will continue to fall, and the Fed will cut rates, and this will spur risky assets to perform well. But this assumption is not priced into the inflation swaps, which now imply US CPI inflation to accelerate to 3.5% over the next year. We have not seen levels this high since August 2022, when realised US CPI inflation was running at over 8%.
The swap market is also pricing in higher inflation further forward, with a 2.7% CPI rate implied 5 years forward. This contradicts the current assumptions around Fed rate cuts, where markets are implying nearly 1.5% of rate cuts in medium term.

US implied CPI inflation rate

Another factor is the fiscal easing from tax cuts in the US, which could fuel short-term US growth and increase inflationary pressure. Other alternative inflationary indicators, such as business price surveys, show clear warning signs that inflation could be a bigger problem than rates markets expect.

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

Given this environment, we are reducing our overall duration exposure, particularly by cutting US duration where we are now underweight. Our remaining long DM duration positions mainly come from GBP and NOK. We remain short EUR rates generally, which have sold off over the month along with GBP due to large volumes of issuance and a lack of market appetite to absorb the longer dated notes.

On the GBP side, we see more modest inflation expectations than the US, so we are long GBP breakeven inflation on both valuation grounds and as a cheap hedge for some of our long duration positioning.

Our more structural long positions in EM rates and FX remain, although we have trimmed these slightly in our overall defensive shift in the portfolio. Valuations here remain historically cheap, and we are inclined to keep long exposure as our primary driver of risk in the portfolio. Our long EM FX positions are against USD and increasingly GBP. We have trimmed short dollar exposure due to the possibility of a more hawkish Fed, while our GBP short has grown due to a rich relative valuation and as a hedge to our gilt exposure.

On credit, we are still outright short via a US CDX High Yield and iTraxx XOVER, which we deem to be the best expression of our bearish view on credit valuations due to the high liquidity and high beta.

Outlook

Global IG credit returned 0.69% in August with spreads widening by 3bps. At the start of August, spreads were driven wider by US tariff deadline fears and weaker than expected labour market data, before recovering into mid-month as expectations of a September rate cut by the Fed increased. This was bolstered by a consensus US CPI report and dovish comments from the Fed Chair at Jackson Hole. However, global IG spreads lost momentum after testing multi-year tights and marginally retraced into to month end.

IG spreads (bps) continue to return to tights

Our positioning across global IG credit is broadly defensive, given expensive valuation levels. We continue to take profits into market strength, de-risk and position ourselves to be able to take advantage of wider spreads.

US IG credit returned 1% in August with spreads widening 2bps. While corporate fundamentals and market demand for US IG credit remain relatively robust, we continue to see warning signs in the US economy. A real-income squeeze for middle-income US consumers, where wage growth is tracking lower than inflation, combined with jobs growth primarily driven by the healthcare sector now, we see risks to US consumer spending and the labour market skewed to the downside, and insufficient compensation at current spreads.

US payroll growth has slowed sharply

While new issue supply was muted in August, we expect a pick-up in September as issuers make the most of low interest rate volatility. With a healthy supply pipeline, we expect there will be opportunities to selectively add credit risk where new issue concessions are attractive.

Euro IG credit returned 0.02% in August with spreads widening by 5bps. Markets expect that the ECB has finished cutting rates for the time being, a sentiment we agree with unless the Fed cuts rates substantially this year. We remain underweight European duration in our Euro funds based on the view that growth will surprise to the upside.

In credit, we continue to be underweight in Euro IG. While persistent demand for yield may sustain spreads at post-GFC tights in the near term, we are inclined to avoid chasing spreads any tighter.

Sterling IG credit returned -0.5% in August with spreads unchanged. UK Gilts have been underperforming US and Europe on fiscal concerns, particularly at the long end of curve. We continue to de-risk in credit and focus on downside avoidance.

Asia IG credit returned 1.3% in August with spreads unchanged. Asian markets performed strongly through August with renewed demand, however we have been de-risking our credit exposure.

Outlook

Global High Yield bonds posted positive returns of 1.1% with spreads ending August almost unchanged despite geopolitical tensions and continued US tariff volatility. US high yield markets outperformed their European counterparts, supported by strong earnings reports and anticipation of potential Fed rate cuts. Overall, we remain neutral given tight valuation levels amid ongoing macroeconomic and tariff related uncertainty.

US HY yields and spreads moved lower

The US HY market returned 1.1%, with spreads unchanged. Initially, spreads widened due to weaker employment data but tightened on expectations of a September rate cut. Moderate inflation, strong earnings for high yield firms, and the Fed's dovish rate stance have contributed to lower yields and spreads.

The primary market remains active, driven by demand for income-generating products and healthy financial conditions, with refinancing activities prevalent as companies extend maturities thanks to stronger balance sheets. There has been a lack of supply from CCC issuance. With spreads at the narrower end of their historical range, impending supply and falling yields could further impact the asset class. Political tensions and economic fluctuations may lead to market volatility, and we keep a slight underweight in US HY.

European HY was nearly flat with a return of 0.5%, with spreads widening by 11bps. The market is experiencing short-term volatility due to political issues in France, although any government collapse is expected to have limited credit impact. Ratings are trending moderately downward, highlighting differences between higher and lower-rated credits, with lower-rated CCCs underperforming. We therefore move to neutral on European high yield amid challenging seasonal dynamics, the resumption of new issues, an uncertain macroeconomic outlook, and some negative earnings reports.

Excluding distressed segments, valuations are at the historically tight end of the range. Nevertheless, resilient macro data and strong demand-side technicals prevent a more negative outlook. Unless macro data significantly worsens, recession risk remains low, limiting spread movements, and for that reason we are neutral on EHY.

EHY: CCCs have underperformed recently

Asian HY experienced consistent gains in August posting 1.2% returns, and spreads tightened by 30bps. Spread compression extended to lower-quality and distressed credits, driven by market sentiment and yield-chasing behaviour. This strong performance was mainly driven by positive outcomes in certain sectors.

We acknowledge that as spreads are near historical tights, macroeconomic and tariff-related concerns persist. Asian and China HY are considered the least exposed to tariffs and developed market slowdowns within global credit, supported by robust bottom-up credit profiles. Overall, we are vigilant against market over-exuberance, however, without definitive signs of an imminent sell-off, we remain neutral and invested for carry.

Outlook

Emerging debt markets posted positive returns in August with local currency bonds (+2.2%) outperforming hard currency sovereign bonds (+1.6%) and corporate bonds (+1.3%). Overall, hard currency sovereign spreads ended August almost flat but some widening occurred in the second half of the month.

EM sovereign spreads took a breather

We have turned more cautious on emerging market hard currency sovereign debt, observing that spreads are trading near tightest level. Given this valuation backdrop, we added some credit protection and are focussed on country-specific catalysts, such as the Buenos Aires elections and October midterms in Argentina, as well as potential progress in Ukraine, which could drive positive spread movements.

In Argentina, August volatility was spurred by sudden changes to the conduct of monetary policy and a corruption scandal surrounding the President’s sister. Ukrainian sovereign bonds initially benefited from hopes of a peace agreement with Russia after heightened global diplomatic activity. Later in the month those gains eroded as progress slowed.

The recent steepening of the US Treasury curve and movement in EM spread curves presents tactical opportunities for trades that have deviated from broader trends. Historically in September, primary markets reopen with many new deals placed during the autumn window. This has traditionally led to the selling of older, off-the-run issues, a process that can pressurize spreads.

We continue to be overweight EM local currency duration but have reduced the magnitude of our longs. A seemingly rangebound US dollar and a generally benign backdrop for shorter-dated US yields should be supportive for local currency returns.

At Jackson Hole, the annual symposium of Central Bankers in Wyoming, US Fed Chair Powell opened the door for a September rate cut amid a softening US labour market. A dovish Fed might enable EM central banks to continue easing cautiously, supporting our moderately long duration position.

EM currencies have performed well in August

Emerging market currencies have performed well in August in general. While the outlook for the broader US dollar remains for further weakness, we see the potential for higher volatility into autumn and feel that critical technical levels have held firm on several occasions across higher beta currencies.

This could indicate that a break requires a very strong risk-on move from here, which seems unlikely given recent global developments such as new tariffs, ongoing international tensions and economic uncertainty. We remain constructive on local currency exposure over the medium term and will look to re-enter positions into year-end, hopefully at better valuations.

• Fixed Income Monthly - August 2025
• 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