Market Review
The first quarter of 2025 proved to be a volatile period for fixed income markets. The anticipated outlook at the start of the year, characterised by expectations of economic stimulus in the US and a lacklustre growth environment in the Eurozone, did not materialise. Instead, the opposite occurred.
With the Trump administration's return to the White House, attention was sharply focused on tariffs, with proposals for significantly higher levies than during the President’s first term. This raised concerns about the potential imposition of broad tariffs on US imports, leading to heightened uncertainty surrounding the US economy. As a result, US Treasury yields experienced a sharp decline over the quarter. Amid increasing investor demand for safety, US risk assets underperformed, contributing to a sell-off in US equities. Simultaneously, Treasury yields fell by more than 40bps, which supported total returns across our US allocations. However, excess returns in the US were negatively impacted by the underperformance of corporate bond markets.
Europe’s reaction to US policy changes was the primary driver of returns over the period. In March, Germany’s new government introduced a historic fiscal easing package, increasing spending on defence and infrastructure. Notably, it established a €500bn fund to be deployed over the next decade for infrastructure and the energy transition. At the same time, constitutional changes were made to allow for potentially unlimited defence spending without affecting Germany’s fiscal metrics. These amounted to the largest fiscal stimulus measures since the German reunification in 1990.
Germany’s actions have since been mirrored by other European countries, which has supported the Eurozone economy and is expected to boost European GDP. These developments were positively received by risk asset markets, with European equities seen as having the potential to outperform their US counterparts and European credit markets poised for relative strength against US credit.
However, the quarter also saw concerns over increased government borrowing in response to higher fiscal easing. This led to the largest single-day movement in bond yields since German reunification in 1990. Over the period, German bond yields rose by nearly 40 basis points, which weighed on fixed income returns in Europe. Nevertheless, the strong performance of credit markets helped offset some of the impact, allowing total returns to remain positive for the quarter.
Fund Activity
During the quarter, the fund delivered a flat return which underperformed the benchmark. Returns from allocations in US and Canadian dollars were negatively impacted by the depreciation of these currencies following tariff announcements. However, the fund’s total returns were supported by the strength of the Japanese yen, which benefitted from the Bank of Japan’s ongoing rate hike cycle, and the euro’s relative strength against sterling.
Notable purchases over the quarter included added exposure to more defensive sectors, particularly in utilities. This included purchases of bonds issued by South East Water and Affinity Water in the UK. We also added exposure to bonds issued by JPMorgan in the US and Nationwide Building Society in the UK to the portfolio.
We took profit in the sale of higher-priced bonds issued by Intesa Sanpaolo, the Italian bank, Natwest Group, the UK banking group, and Becton Dickinson, the US healthcare company.
Outlook
We anticipate continued volatility in the coming months due to ongoing uncertainty surrounding US trade policy, which remains subject to rapid changes. In response, we expect to adopt a more defensive portfolio stance, reducing exposure to corporate bonds while increasing allocations to government debt. We intend to maintain duration risk at a relatively low level by tilting portfolios toward short-term maturities. Banks are expected to benefit from the forthcoming deregulation of the US financial sector, a key policy initiative promised by President Donald Trump.
Within corporate allocations, we expect to continue favouring the financial sector, as it remains relatively sheltered from tariff risks due to its focus on exporting services rather than goods. Meanwhile, we plan to take a conservative approach to allocations in sectors that are expected to be impacted by a trade war, such as automotives, consumer goods and chemicals.
Important Information
The value of investments may fall as well as rise and investors may not get back the amount invested.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
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