Insight Investment

Recent volatility has pushed European credit spreads to more attractive levels, while the underlying technical picture remains supportive. With corporate fundamentals still relatively strong, we think current valuations offer potential opportunities, although a likely heavy new-issuance calendar means selection should remain important.

One of the most striking features of today's fixed income landscape is the contrast between emerging and developed markets. Many emerging-market sovereigns enter this period with stronger fiscal and external positions, while corporate leverage is also lower than in developed markets. At the same time, EM corporates benefit from shorter duration and a very different supply picture, with net supply remaining negative. These structural improvements help explain why the asset class has remained resilient despite considerable global volatility.

The sell-off in high yield has started to create potential opportunities that we have not seen for some time. In particular, parts of the shorter-dated market are now trading below par and offering what we would view as attractive yields without requiring investors to move materially down in quality or extend duration aggressively. We are finding solid single-B issuers offering relatively high yields despite what we would regard as generally supportive fundamentals. This remains a market for selectivity, but in our view the opportunity set has clearly improved.

Demand for AI computing capacity remains exceptionally strong, with companies pointing to multi-year requirements. In our view, that means the immediate risk is arguably less about demand and more about execution. Power generation, infrastructure constraints, funding capital availability and growing political resistance to data-centre construction could all restrict how quickly capacity can come online. The weakest links may therefore sit with highly leveraged intermediaries rather than the largest hyperscalers, whose profitability and balance sheets provide, in our view, a much greater margin of safety.

There are obvious parallels between today's AI investment boom and previous periods of technological exuberance, but there is an important difference – the major hyperscalers entered this cycle with exceptional profitability, strong balance sheets and substantial cashflows. Demand for computing capacity also remains extremely strong and the investment cycle should underpin growth next year. The risks, in our view, lie in the enormous financing requirement, bottlenecks around areas such as power generation, and more leveraged parts of the ecosystem. However, even with some inevitable setbacks, the boost to activity should remain powerful.

The US economy increasingly appears to be moving at two speeds. AI-related investment remains an important source of strength, but housing, parts of manufacturing and more interest-rate-sensitive areas are facing greater pressure. The risk is that these vulnerabilities begin to reinforce one another. If that happens, the aggregate economic picture could, in our view, deteriorate more quickly than individual data points currently suggest, particularly if weakness in AI-related markets also starts to undermine household wealth and confidence.

Recent inflation data have remained uncomfortable, but the reaction in bond markets has been striking. Yields have proved resilient even in the face of stronger CPI and PPI data, with real-money investors appearing increasingly willing to step in. At the same time, we are starting to see tentative signs of weaker consumer activity. We think that combination strengthens the case for duration, particularly further out the curve, where slower growth could ultimately become the more important driver.

The latest inflation data leaves the Federal Reserve with very little room to retreat. Energy-related pressures are feeding through into broader prices just as there are tentative signs that consumer spending is beginning to soften. That creates an increasingly uncomfortable policy mix – the Fed may need to remain focused on inflation even as tighter financial conditions weigh more heavily on growth. The result could be an environment that ultimately favours extending further out along the yield curve. We’re looking for opportunities to build positions, focusing on the ten-year area.

US consumers have proved remarkably resilient, but there are signs that the foundations of that resilience are becoming less secure. Consumption has been growing faster than income, with households bridging the gap through savings and credit, while banks are beginning to pull back from some consumer lending. In our view, none of these signals individually points to an imminent downturn, but together they suggest that higher prices and higher interest rates may finally be beginning to constrain household spending.

The eurozone is facing an increasingly uncomfortable combination of resilient activity and renewed energy-driven inflation pressure. The ECB may need to tighten further if the energy shock persists, but it will be acutely aware of the risk of repeating the mistake of 2011, when rates were increased into an oil shock. Unlike in 2022, inflation entered this episode around target, giving policymakers more room to assess whether higher energy prices generate broader second-round effects. The risk is that tightening too aggressively now could weaken growth sufficiently to require a rapid reversal in 2027.

French government bonds could enjoy periods of relief as political uncertainty ebbs and flows, but the deeper challenge is structural. France's fiscal position ultimately requires difficult choices, and there appears to be limited political appetite for delivering substantial consolidation. That means investors should distinguish between temporary improvements in political sentiment and a lasting improvement in the country's fiscal trajectory. For bond investors, volatility is likely to throw up tactical opportunities, but we believe the election may represent a staging post rather than the end of the story.