Market optimism surrounding the US economic exceptionalism narrative has continued to fade, as sentiment turned sour amid trade policy uncertainty and inflationary pressures. Credit spreads have started to adjust wider, reflecting the negative shift in sentiment. We expect market volatility to persist in the coming weeks, with tariff news continuing to make headlines.

We have upgraded US Treasuries and Developed Markets (DM) Investment Grade bonds from Underweight to Neutral, and downgraded Emerging Markets (EM) High Yield (HY) and DM HY bonds from Neutral to Underweight.

Rates and US Treasuries

The US Treasury (UST) rates curve steepened in March amidst tariff headlines, recession fears and inflationary concerns. Yields along the front end (2Y) declined 11 basis points (bps) to 3.88% while long end yields (30Y) increased 9bps to 4.57%. The 10Y UST yield was rangebound throughout the month, ending March at 4.21%.

The US Federal Reserve’s March Summary of Economic Projections indicated an increase in stagflation risks. The Fed slashed GDP growth forecasts from 2.1% to 1.7% and boosted its inflation forecasts. Stagflation fears were exacerbated by the ISM manufacturing printing at 49.0 (in contractionary territory), while the prices of paid components surged to 69.4.

Tariffs will hurt sentiment and growth, driving down 10Y UST yields over the medium term. However, without any concrete steps to address fiscal deficits, we think investors would demand a higher term premium and this could once again influence long-end UST yields by the later part of this year or next year.

In the coming months, we will watch if the tariff announcements raise the risk of greater retaliation, which will increase stagflation risks. We are also keeping a close watch on the nonfarm payrolls data as well as the weekly initial jobless claims reports for indications of the health of the US labour market.

Heightened uncertainty will likely keep rates volatile. We expect 10Y UST yields to hover around 4% in the near term, but yields could rebound eventually given the risks of higher inflation and rising US fiscal deficits. Hence, we turn Neutral on duration.

Developed markets

With an overall risk-off tone, credit market performance reflected the negative shift in sentiment and spreads have started to adjust wider in March across the IG and HY segments. In March, IG spreads widened by 9bps and HY spreads by 45bps. This marks the largest monthly move since the regional bank crisis in March 2023. Overall, yields have also shifted higher, with IG yields rising by 13bps to 5.41% and by 43bps to 7.51% in HY.

The concern for investors is that US tariffs could be met by retaliatory moves, which could lead to another round of escalation. Sectors targeted by tariffs will be most exposed, with the five largest US trading partners within the EU – Germany, Italy, Ireland, France and the Netherlands – likely to be most affected by US tariffs. The UK is less likely to be impacted given its greater reliance on a service-based economy.

Tariffs will be a growth headwind for all counties affected. With greater economic uncertainty, there is room for credit spreads to adjust wider. Spreads remain at historical tights in both DM IG and DM HY. We expect markets to remain tentative as investors digest tariff announcements but think that opportunities could emerge with the ongoing dislocations in the market.

Given the downward pressure on UST yields due to the increased recession risk, we upgrade DM IG bonds to Neutral (from Underweight) while downgrading DM HY bonds from Neutral to Underweight.

Emerging markets

With a wide range of variables and uncertainties in 2025, we remain Neutral on EM IG credits. A stronger USD and increased tariffs should translate into wider EM spreads over the next 12 months, but strong technical factors are important offsetting considerations.

Asia

Asia performed in line with the broader EM region in March, with HY outperforming IG. Across major markets, China and Korea were top performers, while Indonesia was dragged by country specific developments.

Asia appears hardest hit based on reciprocal tariffs announced on 2 April, with HY spreads widening 166bps since the announcement - more than the 30bps decompression in IG as of 7 April. We expect near term macro uncertainties to drive further spread widening, although lower UST yields could support total returns of very high-grade credits. We stay cautious on low-quality credits due to insufficient market premium amidst uncertainty.

Slower growth and currency volatility could create headwinds to Asian credit fundamentals if tariffs are sustained. Prolonged uncertainty could also further erode consumer/corporate confidence and dampen risk sentiment in the immediate term.

Chinese exports to US now face the highest total tariff rate at more than 100%. We expect weaker activity growth in China in coming months and for the Chinese authorities to announce additional stimulus measures to boost domestic demand and partially offset the tariff shock.