2Q25 Market and Strategy Update (March 26, 2025)

Catherine Matthews: Welcome everyone. I'm Catherine Matthews, Global Product Specialist at Western Asset. Thank you for joining us today for our Second Quarter Strategy and Market Update with our CIO Michael Buchanan. There has been significant policy change and that's relating to trade, government, jobs, foreign policy under this new US administration. And Michael will share his insights on our global economic outlook, our expectations for growth and inflation and central bank policy and the implications for fixed income markets. At the end of our webcast, there'll be time for a brief question and answer session. So please do submit your questions into the Q&A box. You might also want to download the presentation slides, which are now available on your dashboard. As we started this year, we were optimistic about fixed income returns, and that was primarily driven by the benefits of higher yields available. But we were thoughtful that there could be episodes of market volatility, particularly due to the incoming Trump administration and their policies. The unpredictability and scale of the policies that have been announced so far has definitely increased uncertainty. And we've seen a pick-up in in market volatility with a sharp correction in US stocks. But we've also seen as we can see here on the slide, really quite a sharp divergence in fixed income returns. Strong returns from US government bonds on the righthand side and many emerging markets. But negative returns as we can see in government bonds on the left from core eurozone government bonds and in Japan. The spread sectors, they've continued to give us positive returns, but spreads have ticked wider. And at the bottom there you can see the dollar's retrace with a weakening dollar over the year to date. So perhaps, Michael, we could start our discussion today thinking about the drivers that we're seeing here behind this divergence of returns and in particular with the big changes in the US and the eurozone.

Michael Buchanan: Great. And yeah, thank you, Catherine, and thanks to everyone for joining us today on our webcast to hear our latest thoughts. Uh, to start with, as you said, Catherine, we were optimistic going into the year for the prospects for returns for 2025. Um, and that really remains the case as we get closer to, uh, ending the first quarter. You also mentioned that we had an expectation for volatility. And as you highlighted, you know, we definitely saw that play out in the first quarter. You look at the difference between, you know, quarter to date returns for Mexico and Brazil, government bonds versus Japanese and German bonds for instance, that you talked about. You know, that's over a thousand basis points of performance disparity. So definitely seeing some volatility. We think that's going to stick with us for a while. Um, coming into the new year, the market narrative was really all about the expectation for continued outperformance of the US economy, driven largely by Trump tax cuts and deregulation. And in contrast, there really was this deep pessimism surrounding the eurozone recovery and also prospects for growth in China. And I would say that this trade really peaked out late in 2024, which you could see at, in the chart that we're showing you. This is the Citi Surprise Index that measures how data is coming in versus expectations. And the more positive numbers mean data is coming in stronger than expectations. The more lower they are, the more it's coming in below expectations. So during the first quarter, we saw a meaningful decline in the US numbers while European numbers have dramatically improved. Three catalysts for this really. One, the data. You know, the data in US has generally just come in a little softer, while Europe has come in a little firmer than expectations.

Michael Buchanan: Secondly, you know, I talked about that unwind of the US exceptionalism trade. Drivers of that have been, you know the uncertainty on tariffs, the potential severity on tariffs, potential retaliatory measures that could be taken on tariffs. And as I mentioned earlier, just softer economic data. And then that final point I would say is really what we saw in early March following elections in Germany, where there was an announcement of a massive infrastructure investment, along with a robust fiscal package that called for significant increase in European defense spending. So let's move on to the next chart and just see how this has played out. You can see that the lower chart really kind of shows you the difference between the path of the U.S. 10-year Treasury compared to the German government bund. And you can see this really has translated into dramatic underperformance of German government bonds versus US and really other European fixed income markets as well. You know, have kind of tagged along with that with that underperformance. The spread between these, between these two bonds, which you can see was about 220 basis points at the beginning of the quarter. That compressed to about 140 basis points. That's a really big move. And again resulted in that significant performance differential between Germany and the US that you showed us in your opening slide. So again, you know, US yields have been somewhat lower during the quarter. German bond yields notably higher, mostly in response to the fiscal proposals and the potential upward effects on growth and inflation, and the expectation for additional net borrowing. And we're going to talk a little more about that later.

Catherine Matthews: It's interesting how all of these government proposals and fiscal policy announcements in the eurozone, for example, have been moving markets really so dramatically this quarter. You know, much more so perhaps even than the previous discussions that we had maybe a couple of quarters ago was almost entirely on inflation. We've also seen China, for example, announce fiscal measures to boost their domestic growth and legislation also to support technology innovation. And how are you seeing all of these government actions impacting your outlook for the global economy and central bank policy? Has our outlook for fixed income markets evolved since the last webcast earlier in the year? Um, well, as we said, we were optimistic about the prospect for fixed income returns, albeit with some volatility.

Michael Buchanan: Yeah. Um, you know, so as I mentioned, if you go to the next slide. We were constructive on fixed income in general for 25. And we continue to be. I think in our last webcast, I talked about how three of the last four years have really been a challenge for fixed income investors with just the backdrop of of higher rates. But it's important because that really has set the stage for the opportunity that we see now. Specifically, overall yields, as you mentioned, are relatively high. So that's always a great starting point for fixed income investors. And then you combine that with we think global growth is downshifting somewhat but also going to remain solidly in positive territory. We're going to talk a little more about that later. We do see growth converging across a lot of major economies, with the US and China moderating somewhat, and the eurozone and Japan improving, at least mildly. We do recognize and you mentioned this, that uncertainty is really elevated right now. Um, you know, again, especially regarding tariffs, are they a negotiation tool? To what extent are they going to be sectoral? To what extent are they going to be retaliatory? There's a lot of unknowns. And we know that with the Trump administration, policy can change abruptly. So the outlook for both growth and inflation is really cloudy. Regarding the labor market, companies don't like that uncertainty. You know, we get feedback from our research team all the time. And, you know, we're hearing more and more about uncertainty. And we think it's definitely going to be impacting to some extent hiring plans.

Michael Buchanan: So we do see a softening of the US labor market and even perhaps a little more cautious spending by consumers could be offset a little bit by lower borrowing costs, lower energy prices. We'll have to see how that plays out. Um, we do think that this is really more of a moderation of growth rather than a recession. Well, you know, you can't take a recession risk off the table, but we still think it's a lower probability. And let's not forget that the positive impact of of tax cuts likely coming later, or at least the extension of tax cuts and an easier regulatory environment. So we do have some offsets on inflation, usually something we talk about right away. It seems to be kind of taking a back seat right now to some of the other aspects of what's going on in the global economy. But we do think that inflation is globally making its way to target or even in many cases already there. Here in the US, we're seeing some inconsistencies and that progress has been a little more stubborn. We think actually in the near term, it's likely to tick higher before reestablishing that downward trajectory toward the target of 2%. We do think, importantly, that central banks have room to cut rates, and that's really important. It's not necessarily about, you know, how many cuts or the timing of those cuts. It's really about, the idea that if needed, they have room to cut rates. And we think that's an important aspect of of the fixed income market right now.

Michael Buchanan: In terms of implications for the markets, the fed says this, we believe this. Real interest rates, we think, remain restrictive. So again, central banks have room to cut. Public debt levels. I think that's something that everyone's talking about. They continue to rise. So we do think that yield curves could very likely steepen over these fiscal concerns, these fiscal policies, spread sector fundamentals remain supportive. Valuations kind of reflect those strong fundamentals, unfortunately. So we'll talk more about that relative value opportunity, and how we are handling that within our portfolios. We do see pockets of opportunity out there in developed market rates, for example, in Europe, UK, Australia, where we remain overweight, duration, uh, commercial mortgage backed securities stand out to us as one of the more compelling relative values. Our team has done a really nice job identifying opportunity there and guiding all of our strategies and within corporates and emerging markets. You know, I would say it's a little more idiosyncratic still seeing opportunity, but it's not necessarily at the index level or the overall market. You really got to do your work and dig in. Um, and just a final point again, you know, we talked about it, but we do expect increased volatility. I think that's a really important aspect of the market now. And we're going to talk about how we plan to deal with that volatility. Also how we plan to take advantage of it. So if we go to the next page.

Michael Buchanan: So this page basically shows you the global economy and what the expectations are for the next couple of years. Like I said, we expect the US economy to downshift to a slower, below trend growth rate in 2025. More caution from consumers, more caution from businesses. Um, again, we expect some slowing from the from job growth given that uncertainty. Um, and probably more directly as a result of some of these government job reductions and the secondary impact on the private sector. And finally, just, you know, the potential of of immigration policies, there's just a lot of unknowns there. The eurozone should pick up due to a reasonably resilient consumer, helped by lower inflation. Also, moving into 2026, we expect to see some benefit from the EU defense and German infrastructure spending proposals that I mentioned earlier. China continues to be a struggle, really, and it's all really about the property market and just an inadequate policy response to that property market, also hampered by challenging demographics and fragile consumer confidence. So you know that slower growth trend that we've been witnessing in China, we think that remains at least for the near term. But when you put it all together, advanced economies we think should remain just shy of 2% annualized growth. Again, you got the US and China sort of slowing. You've got the eurozone and Japan picking up somewhat. And we do. As I mentioned, we believe that a chance of a recession is is not,is not an impossibility, but it's a lower likelihood.

Catherine Matthews: So you mentioned we've definitely seen a downshift in expectations for us growth. And perhaps you could look at more detail into the potential growth impacts. And it seems that a lot of these are stemming from the Trump administration policy initiatives, which, you know, I think ahead of the election, the markets have been quite optimistic about about the impact for the US economy. But but now those thoughts are downshifting. So how could those sort of play out over the next couple of years?

Michael Buchanan: Yeah. If we go to the next slide, it's important to um, it's important to understand the timing of these initiatives. So in his first term as president, Trump's timing emphasized tax cuts in the early stages of the presidency, followed later by by tariffs and tariff negotiation. This time around, you know, we're really having to kind of eat our vegetables first before getting dessert. So you know, tariffs first. That's causing as we know, a lot of uncertainty a lot of concern, a lot of market disruption. But later we think again it's likely you see extension of tax cuts and some benefits from from deregulation. So tariffs are likely to initially weigh on growth by reducing real income, tightening financial conditions and increasing just overall policy uncertainty. But again, the prospects for tax cuts or at least the extension of tax cuts, combined with regulatory easing and regulatory easing, I think, you know, we really need to to to not discount that, especially in the banking sector, which I think is very likely to be at the epicenter of some of this deregulation, you know, that can have a multiplier impact on the broader economy. So, you know, they're going to provide some offsets and it will take longer to materialize. So in the short term, you know you're going to see a net impact that's negative but moderating over time. And, you know, we should kind of get back almost to, you know, ground zero, um, you know, over a couple year period.

Catherine Matthews: So thinking about the labor market and the impact of tariffs and also the Department of Government efficiency, their related layoffs and early retirement incentives. What are your thoughts on labor?

Michael Buchanan: Well, um, you know, we feel the labor market is in good shape with still low unemployment. But we think all this uncertainty has to translate into some softening. As I mentioned earlier, with business hiring, being at least nervous or in many cases just on hold until there's more clarity. There has been a lot of talk about the Department of Government Efficiency (DOGE) layoffs, and the increase is dramatic. You can see that on the on the chart to the right. But the overall numbers that we're talking about are relatively small. And, you know, you have to remember that federal workers only represent about 2% of the overall labor market. So no question, there'll be some, you know, some follow on or related impact to the service industries, probably mostly around, you know, Washington, D.C. and that area. But we don't see it as something that is going to be hugely tragic to the overall labor market, just kind of consistent with our view of a general softening of the labor market. Um, if we go to the next page, just talk a little bit about the consumer. We're watching the consumer really closely, big driver of the overall economy.

Michael Buchanan: And we still see the consumer is healthy. You know, despite these these labor market trends I just mentioned, you know, unemployment is still very low by by historical standards. Workers are also seeing real incomes continue to grow. And while we recognize there are some indicators. Credit card balances for instances that are growing, overall debt to income levels remain low, remain, you know, pretty manageable. A few things that I would say that are catching our eye. And as I mentioned, we get a lot of active feedback from our credit research team related to companies they follow. And we're starting to see some signs of slower growth, I wouldn't call it, you know, again, flagging or signaling recession, but airlines communicating some indications of demand pullback, especially in government related travel. You know, in addition we saw some patches of concern in retail home building autos with non-prime auto delinquencies going higher. And even in some consumer product companies, again, nothing recessionary, but certainly not consistent with U.S. exceptionalism. And something we're watching closely to get a better gauge on the longer term trend of the US economy.

Catherine Matthews: Similarly, in consumer prices. So the underlying price increases in the US, they've been quite benign recently as well. That's across both the sort of CPI and PCE price indices. So with um tariffs again and implications for higher core goods prices, how are we expecting to see the trend in inflation over the rest of this year? I certainly know some expectations have jumped really sharply.

Michael Buchanan: Yeah. No, as you say, I mean the inflation expectations and the survey data have exploded in the last few months due to concerns over over tariff policies that are coming out of Washington. In near term, CPI swaps have ticked up somewhat, but the overall market prices are expecting just a more modest impact. We think that the inflationary impact from tariffs won't be fully passed through to consumers and is more likely to be a one-off effect on price levels rather than an ongoing inflation event. We do think that the bond market has mostly priced in these tariffs. Again, we'll have to watch policy negotiations and policy shifts really closely. Additionally, if you look at longer bond yields that incorporate the ultimate impact of slower growth, you see in the in the longer dated TIPS market, for instance, real yields have fallen in breakeven inflation spreads are basically unchanged from when the higher tariff news hit the tape.

Catherine Matthews: So rates have held pretty steady by the fed for the last two meetings. What's your expectations on fed policy for the rest of this year, and what are your thoughts on the messaging we had conveyed to the market after the last fed meeting last week.

Michael Buchanan: Yeah. I guess, um, you know, I think our belief is that the fed is going to be willing to look through what's likely to be at that uptick near term in inflation. It may delay the pace or even the magnitude of cuts, but we think still directionally cuts are the likely path going forward for the fed. We believe and the fed has communicated that the policy rate is currently restrictive. Longer term we think there's progress on inflation. And again, even though that's stalled, we think that, um, you know, ultimately we'll get back to that trajectory of heading towards the Fed's 2% target even. In our last webcast, we said it's going to be difficult that last mile from 3% down to 2%. Still believe that that's the case and still believe we ultimately make progress toward that goal. You know, again, the one thing I would mention, Catherine, is the fact that the fed views themselves as having rates in restrictive territory right now. We do believe that gives them some room, some comfort to cut if needed. And, you know, in terms of financial markets, I think that's, that's that's really important. It's not again, it's not about the timing of cuts. It's not about getting the precise exact number of cuts. It's really about directionally getting the path right and understanding that the fed has some room, has some comfort as needed to respond to market conditions, to respond to challenges that they may see going forward. So I think that's good for for fixed income markets.

Catherine Matthews: With the weaker data that we've had, though, and these dovish Fed comments that we've spoken about Treasury yields, they've already come down from their highs in in early January. And the yield curve steepened a bit. Um, you know, what are your expectations from here and how our portfolio is positioned?

Michael Buchanan: Yeah. So as I mentioned, we think bond yields have already mostly incorporated the impact on growth from tariffs and other policies. So in our broad market portfolios in the US we currently hold a modest long in overall portfolio duration, let's call it, you know, maybe 5% above benchmark. But this really is primarily against the increased risk to equity markets and related or potential related spread sector volatility in that environment. I think I alluded to this earlier, but we continue to have a curve steepening bias, largely driven by our concerns for fiscal challenges going forward.

Catherine Matthews: Thanks, Michael. So now perhaps if we turn to think a bit more about inflation and how we see this moving forward, we've got a chart here of global disinflation. Effectively, you can see the chart shows average inflation across the major 15 economies. And significant progress has been made since global inflation hit 7% back in 2022. Headline and core inflation, they've continued to move gently lower. And core inflation is really now closing in on the 2% that most central banks use as their inflation target. As we've seen, you know, almost all of this, the distortions from the pandemic, they've been normalized and removed from that data. But what's really more unusual is that wide gap between service price inflation and goods price inflation, which, you know, turned into deflationary territory last year. The contribution from goods inflation. while that might be over, we can see that ticking up a bit. And certainly as you've outlined in the US we could see upside risks from tariffs. But we do expect services inflation to generally recede and the gap should narrow. Energy prices they've been relatively benign recently. So again we'd expect headline inflation to map more closely to core inflation. But overall what we see is inflation in a similar range to that prior to the pandemic, albeit maybe at a slightly higher average, but with risk to the upside, primarily from US inflation, as you've spoken about. And that's due to the tariffs. So, maybe now we think more about those other major economies, starting with the eurozone.

Catherine Matthews: Yesterday. Sorry, Mike. I was going to just start and say that yesterday. We did see, um, business confidence in the eurozone pick up on the back of the fiscal measures that you spoke about. And, um, you know, perhaps we can talk a little bit more about those fiscal plans and how they might boost confidence and impact growth and inflation in the eurozone. And also overnight, we had the, ceasefire deal announced in, in the Ukraine. Perhaps you can talk about that a bit as well.

Michael Buchanan: Yeah. So, a lot to talk about there for sure. Let's talk about fiscal first. So as we talked about at the beginning of March, we saw a significant new EU wide defense spending proposal, as well as the announcement of a German infrastructure fund and increased German defense spending. Really big, really powerful. The European Commission has proposed giving member states access to $150 billion loan facility for defense spending, while also enacting what they call the escape clause that will allow member states to increase defense spending from 1.5% of EU GDP to 3%. So together this could translate into up to 800 billion in increased spending. You know, the timeline is uncertain, but certainly the number is significant. The growth impact, however, will be likely a slow ramp. That's our view. That's our thought. Um, and if you put defense spending in perspective and you see it on, on this chart that we're looking at, um, the auto industry in Germany is 20 times bigger than the defense industry. And as we all know, the auto industry is certainly having some challenges, in particular in Europe. So job losses in the auto sector may be significantly more than the gains that we see in defense or related infrastructure jobs. That recently announced German infrastructure fund could allow borrowing of up to 500 billion over 12 years, with with further allowances for for defense spending. So this has the potential to boost economic activity. And, as you alluded to, boost confidence more broadly. But again, you know, the ramp up is expected to be slow with spending split over, you know, a longer period of time.

Michael Buchanan: So given the lack of clarity in the initial proposals and the time lag before the macroeconomic impact, we expect only a modest positive impact on domestic activity in the in the medium term. Regarding tariffs, this could be a little bit of an offset to those positives of fiscal stimulus in the near term. You know, again, the US has threatened to impose a 25% blanket tariff on imports from the EU. We know this can evolve. This can change, this can shift. But it's creating uncertainty. And, you know, we probably think over time it's likely to see something closer to 10%. Again you know, the uncertainty is going to hamper business confidence and investment, potentially offsetting some of the positive impact from defense and infrastructure spending in the near term. Finally, on the on the Ukraine. Nice to see there's the beginning of what looks like a peace agreement overnight. This has a potential to be a positive boost to confidence and likely reduce energy costs further. But the big question really is, you know, is the peace agreement going to be short lived? Is it going to be longer lasting? That's a tough question for us to gauge right now and evaluate. But no question, longer term, Ukraine peace is going to be something that would certainly be beneficial to the market and the overall economy.

Catherine Matthews: Yes, and it would be good also, I guess, for bringing down further the the inflationary pressures that might be coming from tariffs. So again that sort of quite a good offset. And taking all that into consideration, how are the global portfolios and European portfolios that we manage positioned in eurozone government bonds?

Michael Buchanan: So with with eurozone GDP only around 1% in 25 one and a quarter in 26, and inflation on track to meet the ECB's 2% target, we expect that the ECB is going to continue to ease policy with our expectation, two further rate cuts this year. The market is also expecting some rate hikes in 26 and 27, which we see is unlikely. So with the longer-term benefit from the fiscal plans on the eurozone confidence and output, and the increase in issuance that we think is going to be required to fund that, we've increased our fair value estimate of the 10-year German government bond, the bund, from a range of two and a half to two and three quarters. Or, I'm sorry, up to two and a half to two and three quarters from where we were previously, two and a quarter to 2.5%. So we've taken our expectations up slightly. We do expect yields to moderate further towards 2.5%. So we maintain a modest overweight to duration and German government bonds, both in nominal as well as real yields. Also, you know, we're overweight duration in the UK and perhaps Catherine, I'll turn it back to you if you could share the views from our London team on the UK and how we see the outlook for rates.

Catherine Matthews: Yes. Thanks, Michael. Yes, we are overweight in UK gilts and we do expect, similarly to other central banks, the Bank of England, to cut rates further. And there we're also expecting the bank to be cutting rates by more than the market currently expects. UK inflation data we had this morning. That definitely surprised to the downside. And while inflation is going to rise this year you can see that in the bottom left hand chart. And that's due to really to energy-related base effects following higher natural gas prices in the winter. So it's quite technical. But the bank looks through that. And when we look at their forecasts, which is the dotted line, we can see inflation returns to target over their forecast horizon. Growth in the UK, it really does remain really quite subdued. And unemployment is rising. It's above pre-pandemic levels now. This morning we had the spring budget from the Chancellor. And that showed growth with the new forecast from the OBR, growth marked quite a bit lower again as well, albeit picking up next year. But also the borrowing was was well contained. So again today that's given the gilt market some some optimism at the longer end of the curve. But on wages, um, where we're discussing on the right hand side and the labour market, there's definitely uncertainty surrounding higher employment costs that the new Labour government brought in their budget last year. And that shows we can see on the chart, the official wage data has really stayed very stubbornly high. But there seems to be quite a lot of distortions in those. Again, spoken about by the Bank of England as, as perhaps a bit of an outlier, due to its composition and volatile sectors. So looking more at the survey data in the UK, we actually see wage growth declining and hiring intentions are falling. So labour market definitely softening. So overall, you know, a slowing growth picture, low inflation and Bank of England cutting more than the markets expect.

Michael Buchanan: Okay. Thank you. Um yeah. Let's let's go to the next slide. We'll talk about Japan and you know, as I mentioned earlier, Japan's providing some offset to global growth versus the slower growth we're seeing in the US and China. It's really the only major economy where the central bank is still tightening policy. Shortage of labor, that's a structural issue with poor demographics well documented and low immigration. The Japanese economy is expected to grow one and a half to 2% this year. I think that's supported by private consumption and strong business investment. Wage growth is gaining momentum. You know, it's around 3% year-over-year. It's the highest level you can see, I mean, it's pretty dramatic. The highest level we've seen since 1992. So really almost like a sea change that we're seeing in Japan. Higher inflation should see the Bank of Japan continue to tighten policy just to normalize real interest rates. But the pace of hikes we think is expected to be slower perhaps one every every six months. While we see JGB yields higher in the long run, in the short term, we've moved from a short position in terms of overall duration more to a neutral position, as we think a lot of the higher move has already been priced in at least near term.

Michael Buchanan: You know, I've been mentioning China so let's provide some insights on that. We'll go to the next chart on China. Chinese growth continues to decelerate. Again ongoing challenges with the property market, insufficient policy response, you know, continue to tell us at least that that deflationary pressure, is likely to persist or even perhaps deepen further. We do note that sentiment is improving somewhat, albeit from a very, very low starting point. You can see consumer confidence still well below where it was, you know, pre-COVID. As you mentioned early on, Catherine, the fiscal stimulus that's been announced in the form of local government debt refinancing. You know, that's somewhat of a positive. And the PBoC has also signaled a shift in policy to economic recovery with the governor of the PBoC, stressing that China will cut rates and the reserve requirement ratio when the window of opportunity emerges. So, you know, China really just too big to ignore. So we're obviously watching it closely, but really have to take somewhat of a wait and see attitude there. Policy response, that forcefully addresses the challenge in the property market we think is going to be vital going forward.

Catherine Matthews: Outside of China, emerging market rates and effects, despite all the geopolitical uncertainty and the tariff noise, they had a really strong start to the year, as we saw in the slide at the start of the presentation. So despite all that tariff noise, what's your thoughts here on emerging.

Michael Buchanan: Yeah. Emerging markets kind of surprised everyone, I think, and performed really well in the in the first quarter. Really benefiting from what I would say and our team believes is sort of some of that excessive tariff fear that had been priced in immediately following the Trump victory last November, but also benefiting somewhat from the unwind of that US exceptionalism bias that we discussed earlier. So you know, with lower US rates with a weakening dollar, currencies within emerging markets generally perform very well. And that was a big catalyst to, you know, to the overall performance. We're starting to see a bit and you can see it on these slides, a bit of an uptick in inflation. And some central banks have had to tighten policy. So Brazil is a good example of that. You know, both an uptick in inflation as well as having to tighten policy recently. So after a really strong start to the year, we've been reducing some of our our exposure to EM, or at least hedging tactically. The chart on the right, you see that real yields are still high. And we do see some longer-term value opportunities. So still not abandoning EM local currency. But I think overall uncertainty, you know, that keeps us somewhat cautious. I think we want to see how tariff discussions, how policy initiatives play out. We know those can have an amplified impact on emerging markets. So, you know, really waiting for the data to guide us in that respect.

Catherine Matthews: Thanks, Michael. Let's now maybe move on to thoughts on valuations in the credit markets on on this slide here we showed this in our first quarter update. We expected the top line which is US Treasury rate volatility would remain elevated. And indeed it has. Despite policy rates moving lower. But also that we might see spread or risk volatility which have been extremely low. We can see from the chart there last year given those strong fundamentals from corporate bonds. But we expected to see pockets of volatility and opportunities to add. And we see this tick up in credit spread volatility with the volatility in stocks that we spoke about. So do you see those opportunities beginning now with this tick up in volatility.

Michael Buchanan: Yeah we do um we've liked investment grade credit and we've liked corporate credit in general. We think that the, the fundamental backdrop is very supportive. So that's important not just how fundamentals are today but how we see those fundamentals evolving over the next 2 to 3 quarters. And the challenge is, you know, a lot of times the market doesn't give you an easy trade. So fundamentals are good but spreads are tight. We did as you as you said. We thought we'd see some volatility. And we thought that would give us some opportunity to add to higher quality credit during the first quarter. You know, I guess what I would say is we were a little surprised. Investment grade held in very, very well during this, you know, call it this initial bout or round of of volatility. I think that's an indication that demand is still strong both in the US retail and institutional demand as well as Asia and Europe. So still very strong technicals. You know, valuations still even with this little bit of backup trading through historical averages. We don't think volatility is over for the year. In fact, you know again we really kind of talked about that correlation between policy initiatives and uncertainty and how that is likely to flow through to increased spread volatility.

Michael Buchanan: So we think we're going to get some shots to buy investment grade credit or at least add to our positions at more attractive levels. We're going to be tactical on that. In terms of specific areas of opportunity. We remain bullish on banks, in particular European banks. You know, just dramatic improvement there in regulatory capital and overall fundamental health is really, really strong. And ironically, spreads still look cheap when compared to a lot of other sectors and investment grade. So we still think that's an opportunity. Um excuse me. Another area. You know, we've been active in the new issue calendar. Many of our listeners probably know that, you know, you've had a lot of new issue activity. And actually, our team says and views it that, you know, concessions are reasonable relative to where secondaries are trading. So they're doing a really nice job of taking advantage of those new issue opportunities, in particular on some of the higher-quality issuance. Maybe we'll go to that next slide. Talk a little bit about high yield. I would say high quality, high yield is something that we've been watching with intense focus lately. From a fundamental perspective, we think that this cohort of credits is in really good shape.

Michael Buchanan: Balance sheet health cash flow generation. Free cash flow generation. Manageable amortization schedules. Ample access to capital. Many of the credits that we follow in this double B category are what we call rising stars. We think they ultimately have the likelihood to muscle their way to investment grade. And there's some good total return opportunity there. But our challenge is, you know, again, it's been to exercise patience. We kind of already have that trade on. We want to add to it at attractive valuations. We got a little bit of a chance to do that earlier in the month. But the opportunity was was was short lived. And you can kind of see that on this chart. You know we had some, you know, some decent amount of spread widening. But if you really want to take advantage of that, you had to move quickly. So like I said, we added a little bit of exposure. But I think going forward still going to get some opportunity there. And you know, I still think we will be, you know, we won't hesitate to, to take advantage of those anomalies when we see them. Let's go to the next slide. Talk a little bit about commercial MBS. I mentioned this in some of my opening comments, but commercial real estate prices, in our opinion, have bottomed out or come close to bottoming out.

Michael Buchanan: And capital is being deployed to take advantage of of these lower, more attractive valuations in both debt and equity markets. I'm sure we all have stories or anecdotes of capital and examples of capital that's being raised to go out and attack this opportunity. And I think that's healthy. That's a healthy backdrop for this market. We do see the office sector remaining somewhat challenged, but property sectors such as hotels, industrial distribution centers, retailers have all benefited from, you know, the continued economic tailwinds. Another thing that our team notes is that new issue underwriting offers the best quality that we've seen in over a decade with low leverage, in-place cash flow or lender friendly structures, as well as low exposure to non trophy office properties. So, you know, when they do include office properties, they're typically newer properties. You know properties that you know we would call you know a much higher quality A, AA plus type properties. You know and you look at spreads commercial mortgage-backed security market spreads are elevated compared to what we see in some other sectors. So, you know, a nice blend of improving fundamentals but reasonably attractive valuations.

Catherine Matthews: Just before we move on here, I've just actually had a question come in. I thought perhaps we could address it here. It's regarding: Are you worried about any, have you got any concerns regarding defaults that might come through in, in this sector, in commercial mortgages in 2025?

Michael Buchanan: Yeah. You know, you always I would say as a fixed income investor, you know, one thing I learned early in my career is, you know, defaults are your enemy. You always have to be worried about defaults. You know, your your friends are your coupon, your yield, your income. But you know, that can all be taken away from you with a default or impairment. So we always take that risk very seriously. What I would say, and I think, you know, I gave a sort of a clue to this earlier, but all the capital that has been raised, there is a lot of money that's waiting to go and buy some of these more challenged and more stressed properties. We have a lot of evidence from some of our colleagues that, you know, when these types of properties go for sale, when there's a stressed offering, multiple bids. You know, a lot of people show up for those for those auctions. So, of course, you know, I think our goal is to, you know, not really compete in the defaulted category. It's really about buying, performing higher quality commercial real estate. But you do have to be cognizant of, you know, the overall backdrop, but I think defaults are likely to, not be a significant challenge just because of the sheer volume of capital that's ready to go and take advantage of those types of opportunities.

Catherine Matthews: Okay, great. Perhaps we could just maybe then just summarize again that the global outlook.

Michael Buchanan: Yeah. Let's do that. So, again global growth downshifting but remaining in positive territory. That's our view. Further progress on inflation, which, you know, is now very close in many economies to central bank targets. We talked about the US inflation. That's a little more stubborn. It's probably going to take a little more time to get there. But ultimately we think it resumes its trajectory toward that 2% target. Central banks have room to cut rates. So I think that's an important feature within the overall market. They're you know, they can respond as needed. Spread sector fundamentals, we think, are generally pretty attractive. But spreads unfortunately remain tighter than historical averages. So we got to be a little more tactical there about just taking advantage of those opportunities. But I think we'll get them. And like I said, you know, the big theme that we talk about is volatility. We expect volatility. We think you're going to see more spread volatility as the year plays out. And I think we're in a good position from a portfolio positioning standpoint to take advantage of those bouts of volatility.

Catherine Matthews: Thanks, Michael. If you don't mind I'm going to start with with a question. We're going to move on to questions and answers now that come in from the audience. But I have my own personal question which is we're still in our portfolios somewhat overweight or elevated to the various spread sectors versus versus indices, you know, okay, it's less than it would have been a few quarters ago. But with all of this uncertainty you've spoken about and the tightness of spreads and expecting volatility. Why aren't we taking a much more defensive position?

Michael Buchanan: Yeah, it's a good question. You know, I would say that that when we think of the spread sectors fundamentals or actually for all sectors, not just the spread sectors, but all sectors, rates and so forth, fundamentals always guide our investment strategy. That's really important to us. We spend a lot of time, we spend a lot of money on having strongly resourced, research teams that can look at and gauge these fundamentals and evaluate again how they're looking today, how they should evolve going forward. And we think that's important because rarely do you see meaningful, corrections that happen without some clues with the fundamental backdrop. You know, you'll start to see some fundamental fraying, if you will, of credit metrics. And that kind of tells the story of, you know, what could happen going forward. So as we see it right now, we think fundamentals, as I said, are very healthy, are very strong, and it's very likely we could see the market remain at these tighter spread levels. And you know, again, fundamentals would justify that. So we don't want to get overly bearish and you know start to bleed performance in a market where again you know we think the fundamental backdrop is is supportive. We did take measures to to move up in quality to get a little more defensive, to get a little closer to home. So I feel like we're in a really good spot to take advantage of volatility. But again, I think, you know, you really have to let fundamentals guide you in terms of your overall portfolio positioning. And although we're a relative value manager, you know, let's not forget just, you know, the supportive nature of fundamentals right now, very important to us. And, you know, as I mentioned, I think, you know, we've taken some measures to move up in quality and still have a slightly higher beta portfolio, but a good position to take advantage of, you know, of overall opportunity as we see it in 2025.

Catherine Matthews: Thanks, Michael. Another question now. We've spoken about our expectations of subtrend US growth, and a question came in about the US yield curve, which is slightly inverted three months to ten years, potentially indicating recession. And certainly we're hearing some other, you know, market participants fearing recession. Why are our US team more optimistic about the US economy?

Michael Buchanan: Yeah. You know, the inverted yield curve. I forget who said it, but, you know, there's some, saying about, you know, the inverted yield curve is predicted, you know, a dozen out of the last eight recessions. So it's not always the case that you have an inverted yield curve will ultimately yield a recession. We haven't ruled out a recession. I want to be clear about that. I think when we build portfolios, we think of a number of different scenarios. And certainly one of those scenarios is a recessionary scenario. We think it's a it's a lower probability. But again, it's not an impossibility. You know what drives us in terms of how we gauge or calibrate those probabilities, we look at the, the consumer, and even though we're seeing a little fraying, if you will. Just a little pockets of weakness. It's fraying from very strong levels. And really more consistent with with slower growth. Corporate health. You know, corporations are a big driver of the overall economy. Fundamentally, again, as I said, in pretty good shape. So, you know, again, not an impossibility, but certainly something that, you know, that we're, serious about and, you know, have assigning some probability. We also I think it's important, you know, that when we think about, building portfolios, you know, we really try to try to build portfolios that have a lot of different risk factors. Some of those risk factors are directly correlated, others uncorrelated, others negatively correlated. So we want to build portfolios even in the event that we're wrong. And let's say we do slip into a recession. We've got some inversely correlated risk factors that should help provide a little bit of insulation or, you know, just dampen that downside. And an example of that would just be duration. I think those who know us well know that we use duration in a number of different ways, but one is just as a as a negatively correlated risk factor. And that tends to work well throughout an overall cycle.

Catherine Matthews: Okay. Moving on to the next question. And this is about US fiscal policy and concerns perhaps over that direction of fiscal policy. It's raised concerns also about the global demand for US treasuries. What what are your thoughts on this?

Michael Buchanan: Yeah. As deficits have have risen, you know, we continue to hear concerns about, you know, supply demand mismatch in the market for US treasuries. So clearly there's been a shift away from central banks buying massive quantities of, of treasuries. But the demand has really moved back more towards what we'd call price sensitive buyers. So households, hedge funds, mutual funds, pension funds have all increased their, share of US treasuries. And, you know, while the Federal Reserve and foreign public institutions and US banks have decreased their overall holdings, the balance is there you know, those buyers that I mentioned are, are balancing the, you know, the more government-oriented buyers and banks, you know, balancing that out. You know, I think several factors tend to influence demand from these distinct investor groups that I talked about. The level of yields, shape of the yield curve, regulatory conditions. We talked a little bit about deregulations and banks that could actually kick in a little later and allow banks to start getting a little more aggressive in terms of Treasury purchases going forward. So don't rule that out. But also correlations with other risk assets. So you know, there's a lot of drivers that impact demand. I think with the ongoing fiscal challenges and supply concerns, you know, we think this uncertainty around the absorption of Treasury supply will remain an ongoing topic. And, you know, probably likely to lead to some elevated volatility on average and perhaps some higher term premiums going forward. Catherine, I guess I'm going to turn it back to you for a second and ask you a question. You know, again, about the about the eurozone. Have have you been surprised? Has our team in London been surprised that country spreads within the eurozone, haven't widened sharply following the release of the EU defense spending plan and the related infrastructure plan?

Catherine Matthews: Yes, I think that definitely. And, you know, many, many semi-core and peripheral eurozone economies, they've got really acute challenges with respect to their fiscal positions, very, very different from from Germany. I guess the first thing we would cite is that massive 1.5% increase in defense spending is an aspiration. It's not a target. And many countries will find it easier if they fund that spending from loans from the EU, which are going to become available. So again, also some countries are being quite slow to commit to exactly what they're going to be doing in defense spending. And some may repurpose existing what we call cohesion funds and their funds where you can invest in environmental or transportation infrastructure projects, for example, and they could just repurpose those towards defense, and avoid any significant increase in national debt issues. So I think these are the things really that have supported, spreads relative to, to Germany, um, which I think the knee jerk reaction from the market might have been to expect spreads to move sharply wider. Maybe we got time for one more quick question before we finish up here. So, Michael to you, is duration still a reliable hedge for fixed income investors against spread risk positioning?

Michael Buchanan: Yeah. The short answer is we believe, yes, it's a reasonably reliable hedge. Or as I mentioned earlier, negatively correlated risk factor for fixed income portfolios. Our macro team has done a lot of great work on how durable or how reliable that relationship is. And we do think there are periods of time when that relationship holds really tight, is a lot more reliable. That typically relates to when inflation is lower, say at or below or close to at least central bank target. It becomes somewhat less durable or less reliable as you get to higher levels of inflation. But the relationship still holds. It's just again, it's not as meaningful. So, you know, we continue to use duration in a way that complements our overall portfolio positioning. And I guess the other thing I would add is in a true risk off, even if inflation is high. And let's say that, you know, duration isn't quite cooperating or, you know, acting with that durable reliability that it does in, you know, throughout most periods in a significant risk off event, you really do see that duration component do what it's supposed to do. It provides ballast. It provides offset to risk positioning that can be in a fixed income investor's portfolio. So yes is the answer Catherine.

Catherine Matthews: Okay. Great. Thanks very much, Michael, and thank you very much for all of your insights. It's been a good conversation today. And thank you also to all of our listeners for joining us. As we wrap up, our listeners are going to be directed to our latest publication, which has just been released, Macro Market Trends for the second quarter. And this paper provides our global economic perspectives on specific topics. Last quarter, we wrote a paper with the input from the team around the world on the potential impact of tariffs on global fixed income markets. In this quarter, we've spoken a lot about today, the rising debt levels globally. So as always, we welcome feedback from our listeners and would appreciate it if you could complete a short survey that will pop up at the end of our webcast today. And again, thank you very much.