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Talking Heads podcast recording with Olivier De Larouziere

Daniel Morris: OK, Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing fixed income markets. I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Olivier De Larouziere, CIO of fixed Income. Welcome, Olivier, and thanks for joining me.

Olivier De Larouziere: It’s a pleasure to be here.

DM: So much has happened over the last couple of months, Olivier. All the movements and markets haven’t really gone as expected. One of the most notable moves in the markets is this significant divergence between US Treasury yields and Bund yield reflecting evolving attitudes towards the outlook for the US versus the eurozone. So, let me turn it to you. Maybe you can give an update on current events in fixed income markets.

ODL: Maybe I can take you through a few changes over the last month. If we start by US rates, so Treasury rates for example, two-year rates are down by 17 basis points when 10-year rates are up by 18 basis points. Are rates globally higher? No, you see a dislocation in the shorter versus the longer maturities. Investors are asking a premium over time on buying US Treasuries. Have we seen the same thing in Europe? Absolutely not. Yields have come down massively across the maturities. If we take the German yield curve, two-year rates are down by 50 basis points. Ten-year rates are down by 30 basis points. That’s an interpretation of what’s happening across the globe. The economy should definitely be weaker and in Europe, that means lower rates. That’s exactly what the ECB decided to do again last week, easing by 25 basis points. That’s on sovereign yields.

And then you have the corporate market where we have what we call spreads, so, the difference in yields between corporates and sovereigns. In the US there was a widening – more premium asked for investing into corporate debts on the investment-grade side – by 14 basis points, on the high-yield side by 94 basis points. So, that’s a global situation that is impacting the US credit market as well as the European market.

What stands out for me outside of rates is definitely the currency. The dollar versus euro has depreciated by 11% year to date. So that’s a massive change. That’s probably the biggest impact of a lot of news that we have heard of the Trump administration.

DM: I see a lot of headlines or commentary about expectations for a recession in the US. Do you see pricing in fixed income markets that’s suggest the markets are expecting a recession in the US?

ODL; Yes and no. I can look at implied pricing, what [the] consensus is saying in terms of, for example, central bank actions. If we looked at the numbers today, the Federal Reserve expectations are close to 4 times minus 25 basis points in 2025. That’s quite a lot. Where Mr Trump is putting pressure on the Federal Reserve is in terms of timing. He’s hoping for these cuts to come soon. Where the markets are saying, and this is our base case scenario, is that those cuts might come later this year.

DM: So those pricings, could they be directly interpreted as a recession scenario?

ODL: I don’t think so. Despite the Trump administration, we would be already anticipating some easing from the Fed. The Fed is pushing back those actions because they are concerned by the short-term temporary effects on the inflation side due to the policy in tariffs. It’s about managing how aggressive they need to be. A recession is not fully priced in. More a stagflation scenario in the US. A recession in Europe? Not really as well. Still, the ECB is easing because inflation is now getting close to its targets and might actually come lower. The ECB is concerned by the impacts of potential tariffs on the European economy and taking growth numbers which are pretty low: around 1% overall, probably closer to 0%. Will they be in negative territory and officially in a recession? That’s not our base case scenario. It’s a scenario which is priced in, not the base case scenario for fixed income markets.

DM: At the same time, in the portfolios that you oversee, you have to take positions. Could you talk about what the asset allocation is within fixed income today?

ODL: If I may just add one thing, we insisted so far on macro. The other thing which is absolutely crucial to any asset allocation is liquidity or flows. If flows are not there, premiums need to be priced in and liquidity immediately reduces. This is exactly what happened over the last [few] weeks. Liquidity – how easy it is to buy or sell – has dropped a lot overall on fixed income markets. That is a concern that we have to take into consideration before any asset allocation.

We are selective in terms of sectors, and we are active managers and therefore looking for the best pockets of liquidity. Considering what I described about rates, there’s probably more to come in terms of impact on long-term rates in the US, impact on the currency possibly. Overall, we are positioned very differently between Europe and the US in terms of US exposure. We have massively reduced our exposure because we knew rates would be coming down, which is always very supportive for performance. We are now more concerned about the impact from the credibility angle or the deficit angle on long-term maturities in the US, meaning we are not investing as much as we were in the past. But we are selective, doesn’t mean that we’re selling. It means that we are looking for opportunities. We see currently levels on real yields that offer opportunities. We’re being very selective in some areas, having a reduced exposure in terms of US credit market, especially on the high-yield side.

On the European side, I wouldn’t call it the opposite, but being selective in a different way because rates are coming down. We are buying across Europe, favouring shorter-term maturities, looking for higher-yielding countries, could be France, could be Italy. We’re managing the volatility, and we are selective on the credit market. We still favour investment-grade versus high-yield, but we’re not as negative for European high-yield as we are for the US side. Working very closely with our credit analysts is what we’ve been doing over the last [few] weeks. That proves to be the right approach. This is here to stay for a number of quarters.

DM: Olivier, if we do try to step back and think about the longer-term implications, there does seem to be a more fundamental change taking place, particularly as far as how foreign investors view US assets. For example, if we look at US Treasury yields, to what degree that increase is reflecting the concerns foreign investors might have. There seem to be signs that foreigners are selling US assets, which not surprisingly [is] leading to a weaker dollar. When you think about the long-run outlook for fixed income investing, how have things changed for you?

ODL: Everything that happened triggered a number of structural changes and I insisted on the US side. I didn’t mention the European side. What happened on long-term German rates is a consequence of a new investment plan for Europe: reindustrialisation, more independence and larger deficits. That is extremely important. This has major implications in terms of how investors are looking at fixed income. Everything I mentioned about long-term rates versus short-term rates is becoming more normal. Long-term rates are much higher than short-term rates. It says a lot on how investors should consider fixed income. The number one performance driver for fixed income is carry. Just buying fixed income and holding fixed income for at least a few years. You benefit from that day-to-day yield. That’s why I mentioned being selective, looking at where you are being paid for risks.

This is the income story. This has a number of ways of being implemented. It could be as passive, as a one-time operation, as fixed maturity products. Now might be a good time to capture yields and invest in fixed maturity products. It’s a great way to start and then it’s finding the best timing to do the rest. There we have aggregate funds where we are able to allocate between sovereigns, credit diversification. Some of the products allow in emerging markets which have suffered massively from the dollar effect. Again, many opportunities there. Considering the differences between US and Europe and the rest of the world, I would favour allowing US active managers to invest across the sectors on aggregate products, focus really on benefiting from those levels of yields.

DM: Thank you, Olivier, for helping put some clarity on all the stuff that’s been going on in the markets. If I could highlight a couple of the key points that you mentioned. We’ve seen a steepening of the US yield curve spreads riding on credit, but you highlighted the biggest change has been in the weakening of the dollar, particularly versus developed market currencies. When I asked about whether the markets are pricing in a recession, you didn’t think so either in Europe or in the US. You said in general [you] had been reducing exposure to the US, being selective and with the preference for investment-grade. And then, when you talked about how to invest in this environment, you reminded people that fixed income is about the income. Fixed maturity products or multi-asset fixed income funds where active management allows you to pick the best parts of the market would be recommended areas. Thank you very much for joining me.

ODL: Thank you, Daniel.

DM: That’s it for this week’s episode of Talking Heads. If you would like more information about our fixed income capabilities, please reach out to your BNP Paribas Asset Management contact or check out Viewpoint, our website for investment insights at viewpoint.bnpparibas-am.com. Just before we go, I’d like to mention that the Talking Heads podcast is available on Spotify and on YouTube. For YouTube, visit youtube.com/BNPP AM slash playlist and tap or click on Talking heads. You’ve been listening to the BNP Paribas Asset Management Talking Heads podcast with me, Daniel Morris, and Olivier De Larouziere, CIO of fixed income. Please do join me next week. Until then, take care.