Market sentiment is calmer following a de-escalation in tariff tensions and paring back of recession risks. But we continue to be defensive as we expect tariffs and trade-related headlines to inject volatility in the near future. We continue to be Neutral on duration.

Vasu Menon
Managing Director
Global Wealth Management
OCBC Bank

With continued stability in sentiment, credit spreads continued the tightening trend since the announcement of a pause on reciprocal tariffs. As we expect tariffs and trade-related headlines to inject volatility in the near future, we continue to retain a defensive posture across DM and EM, with a preference for IG over HY.

Rates and US Treasuries

Yields on UST rose over the month in a steepening move, driven by strong economic data, inflation expectations, fiscal deficit concerns and cautious US Federal Reserve (Fed) stance. 2Y UST yields increased 14bps to 4.02% while 10Y UST yields advanced 31bps to 4.52%. 30Y UST yields briefly breached the 5% psychological mark, as a reflection of concerns over the fiscal trajectory not only in the US, but also in Japan which contributed to sell-offs in long-end Japanese government bonds (JGB).

Investors are now focusing on US fiscal debt which is likely to increase further if the “One Big Beautiful Bill Act” goes through the Senate. According to the Congressional Budget Office, the House of Representative’s version of the tax bill is expected to add about US$3.8t to the federal government’s US$36.2t in debt over the next decade. Adding to the uncertainty on fiscal revenue is the US Court ruling on Trump’s tariffs, which now raises questions on the supposed revenues that the tariffs would bring.

Markets have been sensitive to the trajectory of US debt profile, exacerbated by Moody’s stripping of the US from its “AAA” credit rating. We believe elevated policy uncertainty and fiscal concerns will continue to keep term premiums elevated.

Investors continue to look for policymakers to step in should long-end yields continue to rise. This includes potential buybacks, a reduction of supply along the long-end (in favour of Treasury bills) or exempting USTs from the calculation in Statutory Liquidity Ratio (SLR). These measures could provide relief to the supply-demand imbalance along the long-end.

Heightened policy uncertainty from the Trump administration is likely to keep rates volatile. We expect 10Y UST yields to hover in the 4.00-4.50% range in the near term, but remain cautious over the long term given lingering concerns about fiscal deficits.

We remain Neutral on duration. The front-end will likely be anchored lower on expectations of an interest rate cut. The long-end is vulnerable to term premium risk but is skewed to the downside over the near term on growth concerns.

Developed Markets (US, Europe, Japan and Australia)

IG credits continued the grind tighter with spreads at 104bps, about 26bps from the “Liberation Day” induced selloff. HY credits similarly tightened, with spreads at ~330bps, close to 100bps tighter from the April peak. While IG and HY credits charted positive excess returns for the month, total returns were dragged down by negative UST returns.

The primary IG market continues to be active and the steady supply has been well absorbed. This suggests that technicals remain robust as demand remains healthy with investors attracted by higher overall yields.

Lower volatility in the equity and rates market have helped to stabilise sentiment. However, the rates trajectory and steepness of the yield curve remains a big risk. We remain watchful on global long-end rates which could affect risk appetite. In addition, corporates and consumers will have to navigate an uncertain policy backdrop. That is likely to exert some downward pressure on consumer and business spending.

We hold a Neutral position on DM IG bonds and an Underweight position on DM HY bonds. We see risks skewed to wider spreads after the recent strong performance. Yet the outlook for growth remains on the downside.

Emerging Markets

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

Asia

Market sentiment improved in May after the tariff de-escalation, with credit spreads retracing the post-“Liberation Day” widening. However, fiscal concerns in DMs drove term premiums and long-end rates higher in May. This supported HY outperformance over IG during the month.

Frontier sovereigns such as Sri Lanka and Pakistan led year-to-date (YTD) performance within Asia. India, China and Macau also posted reasonably solid returns while Malaysia, Thailand and Taiwan have generally lagged its peers due to their comparatively longer duration profile.

With YTD total returns of 2.3%, Asian credits have outperformed US credits but lagged the broader EM credit segment. Although we continue to expect company fundamentals and market technicals to remain largely supportive, rates volatility and macro developments are likely to remain key drivers of performance in 2025.

Asia HY credit spreads have compressed 31bps YTD, while Asia IG spreads have in contrast widened 17bps. This has brought the Asia HY/IG spread differential to ~370bps – close to early 2021 levels, just before the series of defaults in China HY through 2021-2023.

With credit spreads back to historical tight levels, that leaves limited room for further compression and hence provides little buffer against macro uncertainty.

As such, we retain a quality basis in credits and reiterate that credit selection and duration positioning remain critical.