Fixed Income Monthly - July 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

The global economy is facing significant and prolonged uncertainty, but markets have remained remarkably relaxed. Market implied volatility across asset classes has fallen back from the brief spikes in April. Meanwhile, corporate bond credit spreads have rallied back to near historically tight levels.

Measures of volatility are back to low levels

From the chart we can see how credit valuations are historically rich while the cost of volatility protection across equities and FX markets has rarely been cheaper. US Treasury market implied volatility (the MOVE Index) is around its 25-year average, but still far below where it was in 2022.

We think most risky assets are not adequately pricing-in the ‘real-world’ risks we see in the geopolitical landscape right now. There is an asymmetry in markets where tight valuations make upside potential limited in credit markets, leaving mainly downside risk.
We are expressing this bearish sentiment by extending duration in the fund, particularly in EM but also now in the US.

EM REERs are cheaper than dollars and euros

On the currency side, EMs are still an attractive allocation for us as they screen cheaper than the dollar which has experienced multiple years of relative strength. Twinned with our bearish outlook on the US economy, our view on the dollar is compounded by structural issues with the currency as foreign investors are being pushed away from the US more generally. While many market participants have started reducing USD exposure, we think there is plenty more room for this trend to continue as institutions begin to hedge their dollar exposure.

We continue to like inflation-linked bonds and swaps as a cheap hedge against surprise inflationary shocks. While inflation resurgence is not our base assumption, they act as a cheap hedge against our increasingly long rate duration positioning, as well as our EM local currency and EM FX holdings.

Outlook

Global IG credit returned 1.3% in June with spreads tightening by 6bps overall. In June, risk assets remained resilient, continuing their grind tighter, with credit spreads in most regions back to year-to-date tights. Despite a series of geopolitical risk events this month, fatigued credit markets continue to have limited reactions to oil price volatility and fiscal uncertainty. Globally, hard data has remained strong, with limited evidence that tariffs will cause imminent economic deterioration.

Our credit positioning continues to be defensive across most funds. Tighter spreads are in many cases not offering enough compensation for lingering headline risks and fiscal uncertainty.

IG spreads globally continue to return to tights

US IG credit returned 1.8% in June with spreads tightening by 6bps. Trade tensions and uncertainty remained a dominant market theme, along with significant geopolitical escalation. Oil prices spiked, which disproportionately affected certain sectors, particularly driving IG energy names wider. A ceasefire was swiftly announced, after which spreads retraced any limited widening. We are positioned marginally short in credit as we expect cracks in this resilience.

Increasing evidence points to weakness in the US consumer, so we remain slightly long duration in the funds. Despite persistent concerns of increasing fiscal deficits in the US, with tax cut legislation passing in the Senate, UST yields fell overall in June, with Fed cuts expected by the end of the year.

Euro IG credit returned 0.25% in June with spreads tightening by 7bps overall. US-EU trade and defence relationships continue to be negotiated, but politicians appear to be converging on deals. Markets have had more limited reactions to defence summit headlines and are failing to price in tariff risks ahead of the July pause deadline. Credit spreads remain tight relative to history, which leaves minimal upside, so we remain underweight credit risk in Euro funds.

We have conviction in our short duration position as we are seeing data from the EU surprise to the upside and are positive on European growth. The path for European yields appears to be higher this summer, and we do not expect the relative calm that has taken over markets to continue. We are also seeing some investors looking to diversify away from US assets.

Sterling IG credit returned 1.8% in June with spreads tightening by 12bps. We are leaning long in the funds, with future rate cuts continuing to be the base case, in anticipation of a quiet summer. Credit valuations continue to seem tight, with levels seemingly impervious to tariff and geopolitical risks.

Changes in yields have not been uniform globally

Asia IG credit returned 1.3% in June 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 1.6% and spreads tightened by 29bps. Geopolitical risks diminished recently due to the de-escalation in the Middle East and the positive outcome from the NATO summit. While spreads have recovered, the end of the reciprocal tariff extension could add to volatility.

US HY posted positive returns of 1.9% and spreads tightened by 36bps. US HY spreads remain tight despite the backdrop of trade wars, geopolitical conflict, policy uncertainty, and unsustainable fiscal deficits. The market has remained robust due to solid fundamentals, supportive technicals and low defaults, although these factors may fade as the margin for error is minimal.

However, dispersion remains elevated and there is scope for idiosyncratic single name volatility. The underlying credit health of US HY issuers remains decent, with elevated margins, manageable leverage, and adequate interest coverage. However, credit metrics have been trending lower since peaking in early 2023. At the same time, corporate margins remain near record highs across the market for several reasons, and trade restrictions and tariffs are set to challenge this dynamic too. We have moved to a neutral on US HY amid positive seasonal factors including carry trade dynamics, which should dominate for next 1-2 months.

USHY credit metrics back in-line with average

EHY demonstrated resilience posting total returns of 0.7%, with spreads tightening by 27bps supported by the Middle East ceasefire and capital inflows. Global markets continue to feel the effects of US-imposed tariffs, prompting international investors to reconsider their historical dependence on US assets.

In this context, Europe appears to be in a relatively advantageous position. Although not completely immune to growth challenges, a recession is not the base case. Despite spreads, several positive factors favour this asset class, including low duration, increased refinancing activity resulting in higher coupons, solid fundamentals for European banks, low default rates and above-average recovery rates.

Additionally, the fall in inflation offers the ECB the opportunity to reduce policy rates. Germany's fiscal policy may further stimulate growth, with government spending expected to stay high. For these reasons we continue to maintain an overweight in EHY.

Low duration supports EHY

Asia HY posted positive returns of 1.4% and spreads tightened by 24bps. Performance was driven by a combination of attractive yields, short spread duration and stable fundamentals. Buoyed by generally favourable market conditions, it seems plausible that risk assets will continue to perform as we move into the second half of the year.

While there are likely to be challenges along the way, it would be surprising if the market reacts as strongly as it did back in April. The next significant market shift may come from factors that investors are not currently focusing on. Overall, we continue to be neutral on Asia HY and focus remains on individual issuers.

Outlook

In June, emerging debt markets delivered positive returns across asset classes, with local currency bonds (2.8%) outperforming hard currency sovereign (2.4%) and corporate bonds (1.4%).  During the period, tensions in the Middle East boiled over into military action by Israel and the US against Iran’s nuclear facilities and other strategic targets. Despite this, emerging markets bonds mostly rose in value as investors perceived that the conflict would not lead to severe disruptions of maritime trade through the Strait of Hormuz or that an initial rally in crude oil prices would eventually peter out.

Oil spike had limited impact

We remain cautiously positioned generally in emerging market hard currency bonds. Compared with historical values, EM credit spreads appear tight, but selective opportunities offer good return potential. Within the higher yielding section of the market, some divergence has occurred in June; newly published debt statistics in Senegal put debt/GDP at over 120% leading to significant underperformance for country’s bonds, while rating upgrades for Uzbekistan underpinned the trend for lower risk premia.

In primary markets several inaugural issuers placed bonds, some at attractive valuations. New issues are a good source of value, but premiums compared with secondary market trading levels have reduced amid reportedly high cash balances among investors.  
We are overweight EM local currencies. Local currencies have appreciated against the broadly weaker US dollar, but compared with the appreciation of the Euro against the US dollar, most EM currencies have some catch-up potential.

In Asia, some countries have used currency appreciation to placate the US in trade negotiations, while in Latin America, favourable terms of trade have underpinned some currencies. European markets are the stand-out performers in dollar-terms, as they even outperformed the strengthening Euro.

We view currency valuations as broadly attractive in an environment marked by accommodative financing conditions, tentative signs of renewed investor interest and a weakening trade-weighted dollar. Therefore, we think local currency markets, despite having delivered solid returns in H1 2025, still offer value. Local market gains this year are mostly a function of interest returns, with capital appreciation from rallying yields only occurring selectively. Thus, we maintain an overweight in EM local currency duration.

EMFX lagged EUR appreciation

If global growth moderates gradually rather than contracts sharply, amid weaker US consumption due to tariffs, we expect the US Fed will cut policy rates several times. At the same time, many emerging economies may face disinflationary pressure due to excess Chinese supply of goods. In this modest slowdown scenario, we believe EM bond yields are likely to trend lower, creating attractive returns through capital gains.

• 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
• Fixed Income Monthly - January 2025