Update Bonds: Calm for now but real test is yet to come

Spreads on corporate bonds have also reversed much of their spike. For high-yield bonds, that still means considerably higher levels than at the start of this year, as spreads had already widened in the first quarter. This was not the case for investment-grade corporate bonds, however, so investors could use this opportunity to reduce these positions, especially if they are concerned that there could still be trouble down the road.

Lower spreads are signalling increasing relief in the market. Many analysts, including the US Federal Reserve in its meeting this week, have flagged that tariffs spell trouble for the global economy. Particularly for the US, tariffs could result in more inflation and lower growth. This was already confirmed by falling sentiment indicators and alarming business survey reports, but has not yet been seen in the actual economic data. Meanwhile, the front loading of imports into the US in the first quarter to avoid tariffs coming later, has blurred our view by artificially depressing economic growth in the US and boosting growth elsewhere. April numbers are still holding up, while there has been relatively less noise from the White House. This has relieved markets, that have gradually moved towards Trump being right and analysts being wrong.

However, the real test will come later in the second quarter and in the second half of the year. As Federal Reserve Chair Jerome Powell said, “uncertainty is at extremely elevated levels, we will just have to wait and see.” Widespread  uncertainty and disruptions in supply chains will take time to work their way through economic pipelines, but it is already too late to avoid or reverse their impact. The longer this uncertainty lasts, the more damage is being done to the economy. Investors who are not that convinced that Trump is on the right track or that the Fed will eventually bail them out again, might be better off positioned on the sidelines for now. We expect investors in high-yield bonds to see even better opportunities to increase their allocation from underweight to neutral. We do not rule out that after that, spread levels could rise further and become too attractive to resist. Just be patient.