We are overall Neutral on fixed income. While the economic backdrop is reasonably robust, we remain watchful of potential volatilities in the coming week due to the upcoming US elections. With lower interest rates expected as we head into year end, we think current yield levels are reasonably attractive and may not be sustained for much longer. We are Neutral on Developed Markets (DM) Investment Grade (IG) bonds and DM High Yield (HY) bonds. In Emerging Markets (EM), we prefer HY to IG. We remain Neutral on duration, preferring the front-end and intermediate maturities.

Rates and US Treasuries

Incoming data point to further progress on US disinflation. As a result, US Treasury (UST) yields fell in July.

The yield curve, while still inverted, has started to lose its inversion, moving towards a steepening bias. We believe UST yields are likely to remain rangebound in the coming weeks. Robust growth, fiscal deficit considerations and expectations for the Fed to pivot to rate cuts are factors preventing yields from rising substantially higher. Conversely, inflation readings that surprises on the upside could dampen expectations about interest rate cuts.

Recent weakness in macro data and the latest inflation readings are consistent with our view that the US is headed for a soft landing. Therefore, we maintain expectations for two rates cuts this year (September and December meetings). While the proximity to the first potential interest rate easing supports lower yields, we maintain a Neutral positioning on duration. The anticipated rate cuts are likely to impact the front-end more as we expect the 2Y USTs to edge lower to 4% over the next 12 months.

We believe the curve has the potential to steepen once the Fed moves to cut rates and the yield curve may normalise from its inverted level. The yield curve may further steepen if supply issues from ongoing budget deficits push up term premiums, driving yields up along the long end. Reflecting these expectations, we maintain our preference for the front-end and the intermediate maturities (up to 6Y). Therefore, we maintain a Neutral positioning on USTs and are overall Neutral on duration in fixed income portfolios.

Developed markets

Although spreads are hovering at current tight levels, we do not expect spreads to materially widen from current levels. This is premised on the benign economic outlook, strong corporate fundamentals, and a supportive technical backdrop. All-in yields for DM IG bonds edged 20 basis points (bps) lower over July to 5.47%; but we think levels are reasonably attractive and the opportunity to secure bonds at current levels may not be sustained for much longer given expectations for interest rates to fall.

Having said that, the current tight spread environment leaves little margin for error. Hence, we think investors should be selective and raise the defensiveness of fixed income portfolios. We think the front-end and belly of the curve provide more buffer against yield volatility given the higher yield-to-duration cover.

Emerging markets

We maintain a Neutral position on EM and prefer HY over IG. Despite a limited scope for further spread tightening, the prospects of carry from EM HY keeps us Overweight on the sector.

Asia

Similarly, we continue to favour HY over IG in Asia on the still attractive carry. Although spreads are tight in Asia IG, its shorter duration to EM peers is likely to provide some market support.

At the July Politburo meeting, China’s policymakers acknowledged the current economic challenges and pledged to strengthen counter-cyclical policy actions. While there was no imminent major stimulus, as the authorities may want to retain some policy room to deal with potential shocks from higher US tariffs, we expect more meaningful policies to be rolled out, potentially after September, on growing concerns of an economic slowdown. On property, the government reiterated support for inventory purchases but there were no additional measures. Usage of CNY300b relending quotas for property destocking has been low at 4% as of end June. We expect more property relaxation policies if sales slow in August/September but reiterate that game changing measures would likely require direct central government intervention.

In India, despite the BJP losing its outright majority in the Indian general elections, we anticipate broad policy continuity under the coalition government. As indicated in the recent budget announcement, the new government may step up welfare schemes and consumption driven growth. However, we anticipate broad policy continuity including in infrastructure investments and green industrialisation. We remain constructive on Indian credit.