Monthly Bond Commentary - February 2025

Geopolitics dominated financial market discourse in February, with potentially seismic impacts from a deal between Ukraine and Russia (brokered by Donald Trump) and the risk of a trade war between the US and its largest trading partners. Europe, in its customary fashion, responded only in a crisis and began talks of joint debt and a 'coalition of the willing' to fund defence spending no longer provided by the US. These developments are critical to the performance of your portfolio. Treasury yield as a percentage of overall bond yield is at its highest level since before the global financial crisis and must therefore dictate a higher proportion of investment consideration than in recent years.

The Treasury curve has begun to normalise with short end rates falling as traders bet on three interest rate cuts in 2025, following 100bps of easing in 2024. The risk to this outlook are recent US inflation readings which have come in hotter than expected and stubbornly above the Fed's 2% target. Investment bank Mizuho is even predicting no interest rate cuts for the year demonstrating the split of opinions among market participants. Mizuho's position feels overly bearish to us, however, recent years have shown that market consensus can be far from accurate and by year end Mizuho may be bragging that only they called it right.

This all being said, it is not our position to take large bets on the directionality of interest rates, but generate long-term, excess returns compared with our benchmark. In the past year we have been increasing the aggregate duration of our portfolios as the risk to interest rates rising has decreased. However, we are currently more cautious of the long end of the yield curve, precisely because of the reasons Mizuho have a bearish outlook. Our position is therefore underweight long duration assets relative to the benchmark but overweight the 'belly' or middle of the curve; approximately 3-7 years. This is liable to change in the coming months as the impacts of Donald Trump's foreign policy becomes clear and the yield curve responds accordingly.

Corporate bond markets are in a very healthy position. In recent weeks we have seen A2/A rated Mars Inc receive orders of $114.4bn for an eight tranche $26bn deal. This is the largest ever order book for a US corporate bond issue. Additionally, the deeply subordinated Additional Tier 1 market has been active this year with $25.5bn equivalent issued in January and February; 2.3x the volume issued in the same period of 2024. We are confident that corporate debt markets will continue to provide stable income and capital appreciation in the coming year, despite the geopolitical and economic challenges.