Wealth Insights

Bonds Commentary

Bonds: Time To Revisit Positioning, Look Abroad After Treasury Rally

February 2025

It’s been a good start to 2025 for fixed income investors as core and non-core segments alike have produced gains six weeks into the new year. Riskier pockets of the bond market fared best out of the gate, with U.S. corporate high yield and emerging market debt outpacing higher quality Treasuries and investment grade corporate bonds into mid-January as interest rates rose due to expectations that economic growth could surprise to the upside in the coming quarters. But that performance gap narrowed in early February as talk of U.S. tariffs on goods imported from Canada, China, and Mexico led to concerns surrounding the outlook for global growth which, along with some signs of softness in U.S. economic data, put downward pressure on Treasury yields. This led to a rally in longer duration, interest rate sensitive bonds.

Offsides positioning also contributed to the move lower in Treasury yields as trend-following strategies entered February short U.S. Treasuries as signals led them to position portfolios with the expectation that Treasury yields would continue to climb. Portfolio managers were forced to cover short positions as the 10-year yield breached the key technical level of 4.50% to the downside, intensifying the move lower in yields. After a sizable countertrend move lower in yields, positioning is back to neutral and is now less likely to be a catalyst for yields to move sharply lower in the near-term. This backdrop presents investors with an opportunity early in the new year to revisit positioning with an aim at identifying durable, lasting trends capable of driving rates in the coming months versus short-lived overreactions to economic data.

The prospect of U.S. tariffs being levied on goods imported from Canada, China, Mexico, and perhaps the European Union poses a downside risk to U.S. economic growth, but at present we project the U.S. economy to grow real GDP at 2.4% in 2025, with core PCE, the FOMC’s preferred inflation gauge, coming in at 2.4%. With the 10-year Treasury yield hovering just north of 4.5%, this doesn’t leave much room for either economic growth or inflation to surprise to the upside over the near-term without potentially forcing yields on longer duration bonds higher. As a result, we see minimal near-term downside for Treasury yields and are looking at opportunities abroad in developed market sovereign bonds, specifically, as many issues carry competitive yields.

Attractive Yields, Potential Currency Kicker Reason To Look At Developed Market Sovereigns. The U.S. Treasury rally in late January/early February provided a shot in the arm for core fixed income segments, but that rally has us increasingly looking abroad for opportunities to reduce the credit and duration risks in our U.S.-heavy fixed income portfolios. Yields on emerging market debt remain above long-term averages at roughly 6.6%, but after returning 1.7% in January, we’re closer to profit-taking than we are allocating new capital to current positions with credit spreads approaching 10-year tight levels. Tight spreads and a desire to sit out what could be elevated volatility tied to the Treasury market leaves us considering hedged foreign developed bonds as a viable spot to deploy capital as these bonds carry less U.S. duration risk with potential upside should the dollar remain relatively strong.

With eurozone inflation at 2.5%, below U.S. CPI at 3.0% as of January, and with a paltry outlook for economic growth in the euro area to boot, the case can be made that sovereign yields abroad have less potential upside than yields on U.S. Treasuries at present, particularly with the European Central Bank and Bank of England both easing monetary policy in the coming quarters due to lackluster growth. Select nations abroad are also showing more fiscal restraint and discipline with Eurozone debt to GDP averaging 88% vs. the US at 131%, with expansionary fiscal policy unlikely abroad in the near-term. We’re content to wait patiently to see if yields on long-dated U.S. Treasuries can drift lower still, as 4.25% or thereabouts on the 10-year U.S. Treasury yield would make it easier to take off our overweight to core, investment-grade bonds stateside and reallocate that capital into developed market sovereigns abroad.

As of February 13, 2025