MACRO AND MARKET REVIEW
June proved to be another constructive month for fixed income investors, with improvements in the Middle-East providing respite. Government bond markets continued the recovery from their war-induced volatility, while credit moved marginally wider on the month despite improving sentiment around energy markets. Euro-denominated assets again outperformed many USD counterparts, supported by stronger duration performance in lieu of a softening inflation outlook and a retracement in energy prices.
The key development during the month was the signing of a Memorandum of Understanding (MoU) between Iran and the US, opening a 60-day ceasefire agreement to allow for further negotiations towards a longer-term peace agreement. Following the MoU, vessel traffic partially resumed through the Strait of Hormuz and oil markets responded swiftly, as brent crude fell sharply back towards pre-conflict levels. While negotiations remain ongoing and sporadic security incidents continue to highlight the fragility of the situation, markets increasingly viewed the worst-case energy supply scenarios as less likely.
The moderation in energy prices was particularly important from a macroeconomic perspective. Inflation concerns had dominated market discussions throughout the second quarter, but June data provided the first signs that the energy shock may not spread broadly as had been feared. Eurozone headline inflation slowed to 2.8% from 3.2% in May, while core inflation also eased. Across the Atlantic US inflation was similarly well behaved, showing little sign of broader pass through. Ultimately, although price pressures remain above central bank targets, the direction of travel was encouraging and helped support a broader rally across duration markets, particularly in Europe.
Central banks nevertheless maintained a cautious stance. The ECB raised its deposit rate by 25bps to 2.25%, citing continued inflation risks stemming from the energy shock and a desire to keep inflation expectations anchored. The Federal Reserve left rates unchanged, with policymakers signalling concern that inflation remains above target alongside a still-resilient economy. Despite the progress on the war and inflation front, both decisions emphasised that inflation concerns still trump growth concerns in eyes of central banks.
June also marked the first Federal Reserve meeting under new Chair Kevin Warsh. While rates were left unchanged, the Fed adopted a more hawkish tone, removing language that had previously pointed towards eventual rate cuts. Warsh also signaled a reduced emphasis on forward guidance, declining to participate in the Fed's traditional "dot plot" projections and stressing a more data-dependent approach to policy. The move away from explicit forward guidance will likely lead to more volatility in front end US rates in the coming years, a trend that is likely to heavily shape future fixed income performance.
All in all, in the face of more geopolitical developments fixed income delivered another steady month of strong performance. Further easing of energy concerns and softer inflation data would support a more constructive backdrop for government bonds moving forward, while strong corporate fundamentals and sustained investor demand continued to underpin credit markets. Although risks remain and vigilance is still warranted, the asset class has navigated recent volatility well, leaving credit attractive from a carry perspective and the outlook for duration more balanced than at the start of the month.
PORTFOLIO ACTIVITY
There were two new Fallen Angels in June and two long-term fallen angels returned to investment grade.
UK water utility South East Water was cut to Ba1 by Moody's with a negative outlook on concerns that recent water supply outages reflect an increased "resilience" risk which will not be addressed until its medium and long-term investment programmes are completed. The company faces financial penalties for these outages which will have a negative impact on credit quality. Given the small size of the single issue GBP166m and its age (2004 issue), coupled with the increasing negative sentiment in this sector and suggestions that this company (along with Thames) could be placed in "special administration" suggests the possibility of material negative price action.
Oilfield services company Global Marine is a subsidiary of Transocean, the second largest global off-shore driller. It was downgraded to high yield in 2015 and appears to have defaulted in 2020. However, Transocean now guarantees Global Marine's bonds which has seen the rating improve to CCC and now to "B" which has returned the bond to the Fallen Angel index. In this case there is a single bond, issued in 1998 with just USD245m outstanding and given its somewhat unusual trajectory back into the Fallen Angel index we would not expect it to perform as a traditional "new" fallen angel.
Cruise line operator Carnival was downgraded to high yield in June 2020 following the COVID pandemic and indeed fell as far as B3 at Moody's and B- at S&P. We have been long-term owners of Carnival bonds, noting the very strong and predictable demand in the sector and the company's well considered response to the challenges of the pandemic. We were therefore not surprised to see S&P return the company back to investment grade on a combination of strong forward bookings (93% booked for 2026 with 2027 ahead of previous years at higher prices and volumes) supporting good revenue and cash flow visibility and ultimately stronger financial metrics.
S&P upgraded German wholesale food delivery operator Metro AG to BBB-. The upgrade reflected positive events within the wider EPG (Energeticky a prumyslovy holding) Group of which Metro is a key subsidiary. EPG was upgraded to BBB following a transaction between another EPG subsidiary and TotalEnergies which resulted in EPG Group receiving shares in TotalEnergies worth c. EUR7bn therefore significantly increasing financial flexibility. Metro's rating is directly linked to that of EPG and therefore upgraded one notch to BBB-.
PERFORMANCE
The portfolio delivered a positive return in June out-performing the benchmark. Out-performance was driven by the continued recovery of longer-dated USD bonds (e.g.US department stores Kohl's and Macy's and US fertilizer company FMC) which had been heavily negatively impacted in March by events in the Middle East. We had remained confident in the underlying credit quality of these bonds and had held the positions despite the market-driven weakness. As well as the market-driven recovery in its longer-dated bonds, FMC also benefitted from positive newsflow around asset disposals and potential equity raising to improve liquidity and support refinancing of near-dated bonds. Staying in the chemical space, Huntsman also provided a positive contribution as spreads tightened following its announcement of a merger of equals with fellow chemical player Olin. Finally in real estate, Aroundtown bonds continued to tighten as it called some hybrids and undertook some liability management exercises; repaying bonds a little early. Whirlpool continued to be a slight drag on performance following weak Q1 results and negative rating action and is a name we continue to monitor carefully.
Year-to-date performance is positive and now in line with the high yield index on a net basis driven primarily by very strong security selection within the TMT (Paramount Global, Telecom Italia, SES, Worldline & Xerox) Chemicals (FMC & Huntsman), and real estate sectors (Aroundtown & Citycon) partially offset by weakness in retail & consumer sector (primarily Whirlpool).
For reference, the Bloomberg Global Corporate ex EM Fallen Angels 3% Issuer Capped (USD Hedged) Index delivered a month-to-date return of 0.76% and a year-to-date return of 2.63% for the period ending 30 June 2026.
OUTLOOK
Unchanged since May. Events in the Middle East have had limited impact on company performance as yet, but oil prices will remain high & volatile for some time, increasing costs, inflation and inevitably reducing consumers' disposable income and demand. A high oil price could lead directly to an acceleration in new Fallen Angels from the already challenged chemical sector; and perhaps the automotive sector as well, as consumers delay purchases and reconsider the benefits of electric vehicles. We also continue to monitor the BDC sector carefully.
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