We remain Neutral on duration. Long-end rates are vulnerable to fiscal, inflationary concerns and political noise while front-end yields are biased downwards in the near term on rate cut expectations.

Vasu Menon
Managing Director
Global Wealth Management
OCBC Bank

Inflows into fixed income products remain strong, reflecting optimism about rate cuts by the US Federal Reserve. Credit spreads continued to compress along with easing volatility and returns for the asset class have been positive. As risk premiums have mostly been priced out, we continue to retain a defensive posture across Developed Markets (DM) and Emerging Markets (EM), given little buffer against downside surprises. We continue to be Neutral on duration.

Rates and US Treasuries

Over the past month, yields on US Treasuries (UST) displayed a divergent pattern across the curve, reflecting a shifting mix of monetary policy expectations and political developments. The front-end of the yield curve rallied meaningfully, while the long end remained elevated, underscoring a re-emergence of curve steepening pressures.

2Y UST yields fell to 3.6% by late August, down from levels closer to 4% a month earlier. The rally was driven by a growing conviction that the Fed may deliver its first rate cut as early as September 2025. Fed Chair Powell’s speech at Jackson Hole marked a pivotal point. While acknowledging the progress on inflation, he emphasised rising downside risks to employment, which markets interpreted as opening the door to policy easing. A string of softer labour market data releases reinforced this narrative, pushing front-end yields lower as markets priced in a more dovish path for the Fed.

In contrast, long-end yields remained elevated, reflecting persistent term premium demands by investors. Several structural concerns kept longer maturities under pressure, including fiscal deficits and the inflationary implications of newly installed tariffs. Political noise also influenced market sentiment. Efforts by the administration to pressure the Fed – including attempts to remove Fed Governor Lisa Cook – added to investor uncertainty about central bank independence. While this fuelled dovish bets on near-term policy, it simultaneously reinforced concerns about longer-term inflation expectations and the credibility of the policy framework.

As we look ahead, with political pressure on the Fed persisting and the risks that inflation expectations are picking up – these could drive investors to seek higher term premiums.

For this reason, we remain Neutral on duration. We remain cautious on long-end (30Y) nominal USTs but would keep a close watch on the Treasury’s funding strategies and supplementary leverage ratio (SLR) reform in reducing term premium.

Developed markets

Credit spreads tightened this month in a risk-on move, generating broad based excess and total return gains. Credit spreads are now near all-time tights, reflecting strong investor demand amidst expectations of rate cuts ahead. With the outlook complicated by rising stagflation risks, we remain cautious on DM credits.

Recent releases of macroeconomic data show that the US economy has started to slow. Labour market data in particular are weakening, along with consumer spending and home prices. Meanwhile, default rates have started to pick up within the HY segment. We expect US tariffs to impact credit metrics going forward and US companies will be disproportionately exposed. Companies in the cyclical industries are likely to face margin pressure while high overall interest rates remain a challenge for the highly leveraged issuer.

In France, Prime Minister François Bayrou submitted his government to a vote of confidence on 8 September, with the possibility that he will be ousted. This follows a disapproval of Bayrou’s plans to curb government spending considering the country’s relatively high debt levels. While the French banks under our coverage have strong market positions, well-capitalised balance sheets, broadly stable asset quality and good geographic diversification, we remain cautious of continued political and economic uncertainty for the sector.

We are positioned Neutral on DM Investment Grade (IG) bonds and Underweight on DM High Yield (HY) bonds. We see risks skewed to wider spreads after the recent strong performance.

Emerging Markets Corporates

With a wide range of variables and uncertainties in 2025, we remain Neutral on EM credits. The weaker global growth outlook and currency volatility could translate into wider EM spreads over the next 12 months, but supportive technical factors could be important mitigating considerations.

Asia

Asia credits posted total returns of 1.24% for August, supported by both spread compression and lower UST yields. Hopes of Fed rate cuts have supported long-end performance during the month, although the segment still trailed the intermediate part of the curve year-to-date (YTD).

Compared to most EM peers, Asia credits remain a relatively lower beta play for investors, as reflected by relatively benign spread widening in Asia IG during the recent episodes of market de-risking after “Liberation Day” and July’s non-farm payroll (NFP) data. Having said that, we do expect occasional market volatility arising from political turbulence, geopolitics and tariff concerns. However, fiscal and monetary easing could help to partially alleviate economic headwinds.

In August, S&P upgraded India’s sovereign rating to “BBB” from “BBB-”, citing the government’s commitment to deliver sustainable public finances as a reason for the upgrade. S&P states that it believes the effect of US tariffs on the Indian economy will be manageable. While we are cautious of the trade talks between the US and India and given the currently steep tariffs rate on India, we view the upgrade by S&P as positive for sentiment. We continue to monitor trade developments between India and its trading partners including the US.

Emerging Markets Sovereigns

Hard currency EM sovereign bonds returned 1.6% in August, lifting YTD performance to 8.7%. HY again outperformed IG, returning 1.9% vs 1.3%. HY sovereigns have returned 10.3% YTD compared to 7.1% for IG sovereigns. Local currency sovereign bonds posted a strong 2.3% monthly gain, bringing their YTD return to 14%.

The month’s rally was underpinned by improved global investor sentiment towards the EM universe. EM local currency bonds also remained attractive, buoyed by historically high real yields and residual foreign investor interest. Countries like Colombia and South Africa continue to offer compelling nominal yields above 9%, reinforcing the appeal of local rates.

EM sovereign debt faces both tailwinds and headwinds: While a short-term consolidation in EM currencies is possible, the cyclical downturn of the US Dollar and contained inflation, support continued strength in EM debt. The anticipated Fed rate cut in 4Q25 could further support EM flows, while ongoing tariff negotiations and geopolitical tensions – particularly in Eastern Europe and the Middle East – may inject volatility. In mitigation, improving fiscal discipline, rising currency reserves, and a more favourable global liquidity backdrop suggest EM sovereigns rated “BB” and above remain well-positioned.

Investors are advised to remain selective with respect to frontier markets and distressed issuers such as Lebanon and Venezuela, where apparent tactical opportunities are fraught with downside risks, following significant YTD price gains.

Strong technicals, improving credit metrics, and attractive yields offer a compelling case for continued exposure to EM sovereign bonds — albeit with a need to keep a watchful eye on global trade developments and US monetary policy.