Is the market’s love for the US waning?

March 6, 2025

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In his latest column on the key developments, themes and opportunities in credit markets, Ian Horn examines the recent divergence between US and European bond markets.

The start of 2025 has seen distinct divergence between the US and European bond markets, a trend playing out in a way that would have seemed unthinkable 3 months ago.

Donald Trump’s resounding victory in the Presidential election in early November was welcomed by many investors, believing his pro-growth agenda would be good for US risk assets and provide a further boost to an already healthy economy. At the time, few would have foreseen a situation where European credit markets would outperform the US, or one in which US Treasuries would outperform European government bonds.

But that is exactly the situation we find ourselves in now, suggesting markets are currently more concerned about the US than Europe. As Figure 1 shows, the US Treasury curve has significantly outperformed German Bunds and UK Gilts year-to-date, with the pace accelerating in February. The market is once again pricing in Fed rate cuts for 2025 having discounted that prospect in the latter part of 2024.¹

Deeper cuts

In early January, the market was pricing in just one rate cut in 2025 by the Federal Reserve. At the end of February, 3 cuts were expected, with 2 by the end of September.² Treasury yields have fallen as a result, as the market anticipates Fed support coming sooner rather than later.

Part of the reason for the Treasury rally has been deteriorating US economic data, particularly sentiment-driven data. We can see in the Citi Economic Surprise Indices³ how data has diverged. US data has shifted to being weaker-than-expected, while the opposite has been true in Europe (see Figure 2).

Widespread Revisited

In a recent article, we discussed the spread premium in European investment-grade credit over its US counterpart. But given the shift in sentiment this year, the topic is worth revisiting.

The spread premium has been a persistent theme over the last few years and one many investors will be familiar with. Initially triggered by Russia’s invasion of Ukraine in 2022, it has since been upheld by the failure of Credit Suisse, recession fears, political uncertainty in key economies and the perceived relative strength of the US economy. However, this premium has been fading, a trend that has accelerated in recent weeks.

Figure 3 shows how the spread premium in European BBBs over US BBBs has disappeared over the last 3 months, even turning negative in February.

Trump 2.0, or something else?

We have long felt Europe deserves a persistent spread premium given ongoing political uncertainty, the threat of US tariffs, and generally weaker economic data. Its disappearance has been surprising and might lead some to assume it is evidence that the Trump ‘honeymoon’ is over. However, US spreads have moved sideways since November. If there was a honeymoon, it wasn’t happening in credit markets.

Supply, rather than politics, has likely been a bigger reason for the disappearing spread premium. A return of long-dated US investment-grade issuance has resulted in market duration extending again (Figure 4), which has not been the case in Europe. That supply has perhaps prevented US spreads moving tighter, whilst disappointing supply in Europe may have had the opposite effect.

Looking at spread curves, widening has primarily been evident in longer-dated credit, as Figure 5 illustrates. That is consistent with the increased supply argument, but also a broader risk premium being demanded in US credit. Furthermore, the drop in Treasury yields has brought down the overall yield in the long end, making it less attractive for the ‘yield buyers’ that might typically allocate to this part of the market.

Lower rates and yields have likely resulted in less demand for long-dated US investment grade, while the increase in supply may have compounded that weak technical.

How far will he go?

In summary, although US economic data has weakened and rising expectations of rate cuts have driven a rally in Treasurys, in our view the widening in US credit spreads is due to a combination of macro concerns, lower yields and elevated supply.

Concerns are growing about the US economic outlook and risk of persistent political uncertainty. How things evolve from here may well depend on how far the Trump administration is willing to go to prove a point or risk a potential economic decoupling from the rest of the world.

 

References

1, 2.  Bloomberg, ‘Market implied policy rates,’ as of February 28, 2025

3. Citi Economic Surprise Indices are a measure of the difference between official economic results and forecasts. A score above zero happens when actual economic performance is better than market expectations. The opposite is true when the score is below zero

 

Index descriptions

ER40 – The ICE BofA ML BBB Euro Corporate Index is a subset of the ICE BofA ML Euro Corporate Index (ER00) including all securities rated BBB1 through BBB3, inclusive.

C0A4 - The ICE BofA ML BBB US Corporate Index is a subset of the ICE BofA ML US Corporate Index (C0A0) including all securities rated BBB1 through BBB3, inclusive.

C0A0 - The ICE BofA ML US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

C1A4 - ICE BofA 1-3 Year BBB US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity less than 3 years and rated BBB1 through BBB3, inclusive.

C2A4 - ICE BofA 3-5 Year BBB US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 3 years and less than 5 years and rated BBB1 through BBB3, inclusive.

C3A4 - ICE BofA 5-7 Year BBB US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 5 years and less than 7 years and rated BBB1 through BBB3, inclusive.

C4A4 - ICE BofA 7-10 Year BBB US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 7 years and less than 10 years and rated BBB1 through BBB3, inclusive.

C7A4 - ICE BofA 10-15 Year BBB US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 10 years and less than 15 years and rated BBB1 through BBB3, inclusive.

C8A4 - ICE BofA 15+ Year BBB US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 15 years and rated BBB1 through BBB3, inclusive.

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific companies are for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account. The opinions expressed by Muzinich & Co. are as of March 2025, and may change without notice.

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