Tensions between government debt and interest rate policy

Government bonds

The government bond market is currently under considerable pressure. In the USA in particular, rising budget deficits, the prospect of expansionary fiscal policy and structural debt problems are causing increasing uncertainty. According to a UBS survey, around 50% of the central banks surveyed already consider a restructuring of US government debt to be possible - a previously unthinkable scenario. At the same time, yields remain at an elevated level, with 10-year US Treasuries in particular hovering around 4.5%. The markets are reacting sensitively to political signals: fiscal easing and possible tariffs under the new US government could fuel inflation again and lead to a new rise in interest rates. Defensive positioning remains advisable in the short term. Short-dated bonds such as US T-bills offer attractive yields with low duration. In the medium term, however, a slowdown in the economy and weaker inflation could lead to a fall in interest rates - giving longer maturities potential. In Europe, interest rate pressure is currently lower, which makes quality bonds from core eurozone countries particularly attractive. Overall, a balanced duration with a focus on quality and flexibility is recommended in order to be able to react tactically depending on macroeconomic developments.

Conclusion: We take a neutral view on government bonds.

Investment grade bonds (IG)

The market for corporate bonds in the investment grade segment is currently stable, albeit with limited yield potential. Spreads are close to historical lows, which indicates that valuations are already very ambitious. Nevertheless, these bonds continue to benefit from a solid macroeconomic environment, particularly due to the easing fear of recession in the USA and the prospect of stable or even slightly falling interest rates. Issuers' fundamentals are considered robust and issuing activity remains high, which indicates a healthy financing environment.

Short-dated investment-grade bonds offer an attractive opportunity for defensive positioning with low duration. At the same time, longer maturities could also benefit in the medium term if there is a turnaround in monetary policy later in the year. However, the upside is limited: The narrow spread difference to government bonds argues for a selective choice of securities, whereby the focus should be on quality and creditworthiness. Overall, the segment remains a fixed component in the portfolio for reasons of stability, but requires increased discipline when selecting securities.

Conclusion: We are neutral on IG bonds.

High yield bonds (HY)

The high-yield market has been surprisingly dynamic so far this year. With an index yield of around 4%, high-yield bonds significantly outperformed traditional government bonds. This development was boosted by the robust US economy, falling default rates and issuers' high liquidity levels. Nevertheless, the segment remains heavily dependent on the macroeconomic environment: initial earnings weakness in Q1-2025 and geopolitical tensions increase the risk of a change in sentiment.

The current valuation appears attractive from a relative perspective, but risk premiums are narrow, which limits the buffer in the event of an economic downturn. Political factors such as US tariffs or fiscal policy could lead to volatility in the short term. Selective allocation is therefore crucial: companies with stable cash flows and sectoral resilience should be favored.

In the short term, high-yield bonds offer an interesting addition, especially in combination with defensive investment-grade securities. In the medium term, however, the potential remains closely linked to the further development of the US economy and interest rate policy. A cautious weighting within a broadly diversified bond portfolio is therefore advisable.

Conclusion: HY bonds will continue to offer attractive yield opportunities in 2025. Careful stock selection, diversification and active management are key to investing successfully in this environment. This asset class should therefore be added to the portfolio through actively managed funds in order to minimize risks.

Emerging markets bonds (EM)

The EM bond market remains structurally attractive in mid-2025, driven by increased bond issuance in the first half of the year (over USD 190 billion) despite global uncertainties. The upward pressure on local and hard currency yields is supported by investor demand and diversification trends, including a noticeable de-dollarization.

Hard currency bonds (hard currency) benefit from a possible interest rate catalyst through Fed cuts and falling US yields. Swiss and US asset managers see low spread tightening risks, meaning that although HC securities are unlikely to catch up in the short term, they should remain stable.

Local currency bonds (local currency) are benefiting from a weaker dollar phase, stable domestic real interest rates and positive exchange rate momentum.

The risks include geopolitical tensions such as the threat of US tariffs under the new Trump presidency and fragile global growth - both of which could cause volatility in the short term Conclusion: We currently advise against actively building up positions here.

Conclusion: We recommend a diversified exposure with a focus on high-quality issuers and a balanced allocation between hard and local currency securities.

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Mimi Haas, Lic.rer.pol. HSG, M.A. in Banking and Finance HSG, Partner

_{Sources: MarketMap, Bloomberg and DWS
As of: 07.07.2025}