The Risk of No Landing

• No-landing remains a macro risk in the US

• There is a place for fixed income Goldilocks

• Don’t ignore sovereign credit risk

The eagle has not landed. Some of the recent macro data from the US—hence the eagle reference—may appear on the soft side (like last week’s services PMI), but rest assured, the economy is still doing quite well. For instance, the Market Insights’ business cycle indicator—which tracks and aggregates a broad set of selected leading variables for the US—points to the strongest growth outlook we have seen since early 2022. Quite a few growth drivers are currently flashing green, ranging from robust capex expectations, to the recovered small business optimism or even the resilient labor market. The only source of growth risk may seem to come from the fragile consumer sentiment at this point. Overall, this bears the question: are we in a no-landing scenario? Hopefully not, but this is probably the main macro risk to watch. In a worst-case scenario, the US economy would return to an overheating phase—last observed in 2021/22, which would prompt the Fed to revisit its monetary policy strategy. To be clear, we are not there yet but the risk of no-landing, with its implications for rates and inflationary pressures, seems to be significantly greater than that of a recession at this point. In other words, the US economy is at risk of doing too well. Where does that leave us? The conviction on being long duration now looks to be challenged, with catalysts for pushing rates lower virtually disappearing. The recent macro drivers helping push rates higher have included the widening of the term premium, along with continued momentum in demand pressures. This suggests that this is a macro environment that appears to be more supportive of credit than duration. Credit spreads may look stretched in many places, but absent some exogenous shocks, it is hard to see what could cause a spread correction in the period ahead. In other words, there is nothing wrong with the extra carry provided by credit under the current macro regime.

Looking for Goldilocks. Goldilocks may have vanished in some places, but there are still two areas that remain Goldilocks’ territory, especially from a fixed income standpoint: Canada and the eurozone. In Canada, it still makes sense to favor a long duration bias. There are only 44bp of cuts—or less than two cuts—priced in for the Bank of Canada over the next 12 months, which may easily be exceeded.¹ In addition, Canadian spread valuation looks attractive from a relative value perspective, while the local macro backdrop continues to be fixed income friendly. Meanwhile in Europe, the current policy pricing may still underestimate the amount of easing that the ECB needs to deliver. We believe that the terminal rate will be below 2%. Separately, as highlighted before, EUR credit remains supported by strong fundamentals and technicals. Overall, we look for Canada and the Eurozone for attractive markets where to allocate both duration and credit risk exposures.

Also read: Unlocking Opportunities in Global High Yield Bonds in 2025

There is such a thing as sovereign credit risk. Nobody understands this better these days than my French compatriots. When I spent a couple of days in Paris a few weeks ago to meet with local clients, their exposure to the French government bonds, the OATs, was definitely a hot topic. It is fair to say that corporate credit risk looks a bit safer in some places than for sovereigns. Even in countries that are supported by improving fundamentals, sovereign risk cannot be ignored. Take Italy for instance. We may now be a lot more positive about Italy than they used to be, but it does not mean that the Buono del Tesoro Poliennale (BTPs) should be perceived as risk-free. In fact, if one looks at the credit spreads of BTPs per unit of credit rating, you only get 9bp per unit.² But if you conducted the same analysis for the EUR credit index, you would instead get 12bp. In other words, you are poorly compensated for the credit risk you are taking buying BTPs in comparison to investing in EUR Credit. The same story holds, by the way, when looking at the yield per unit of duration, another relevant measure of risk. The BTP index, which has a duration of 6.4, produces a yield of 49bp per unit of duration—ie a break-even yield of 49bp. In contrast, the break-even yield for EUR credit stands at 72bp, a considerably higher valuation cushion. Put it in a different way, an upward yield move of 49bp will wipe out any positive return of a BTP index position. For EUR credit, however, it would take a bigger yield move (72bp) to produce a total return of 0%. Overall, the total yield for the BTP and the EUR credit indices may be similar, 3.10% and 3.16%, respectively, but don’t be fooled, the underlying credit risk looks very different.

Notes:

A “Buono del Tesoro Poliennale” (BTP) is an Italian government bond issued by the Italian Treasury