FidelityConnects: Global bond markets: Themes to watch for Q2

[00:05:08] Pamela Ritchie: Hello, and welcome to Fidelity Connects. I'm Pamela Ritchie. Fixed income markets entered the year on cautious footing but have held up better than many might have expected. A pretty rapid shift in rate expectations has pushed yields to levels that we've not seen in years. At the same time, demand for credit continues to outpace supply even as issuance tied to AI, data centres, and energy infrastructure accelerates. While volatility has hit commodities and rates credit markets have yet to experience the kind of stress that forces broad-based selling. As our next guest puts it, quote, we haven't seen the capitulation moment yet, end quote. What does all of this mean, ultimately, for fixed income markets and portfolio positioning today? Joining us here today with his perspective on the key trends shaping global bond markets and where he sees opportunity is Michael Foggin. He is portfolio manager of the Fidelity Global Bond Fund joining us live from London. Hi, Mike. How are you? Nice to see you.

[00:06:08] Michael Foggin: Very well, good to see you.

[00:06:09] Pamela Ritchie: Thank you for joining us. I think it's going to get dark in the window behind you as we have this conversation because you're closing out the day. We'll invite everyone to send questions in for you over the next half hour or so. I'd like to ask, first of all, if you can help us understand whether we know, or if you know, what kind of shock this is.

[00:06:30] Michael Foggin: Well, unfortunately, I don't have an easy answer for you. We don't know yet. We've certainly priced in some inflation expectations. We've seen some volatility at the front end of the government bond market. We've seen some drawdown in the equity markets, a lowering of multiples. What we haven't really factored in yet is that sort of higher for longer energy price which really could compress margins and could really force a bigger correction in the equity market which would then flow through to the credit market and see wider spreads there. So far, I think the market is still looking for rays of light, looking for exits, and we haven't yet fully priced in it being structural as we just don't know.

[00:07:19] Pamela Ritchie: We don't know if it's structural. What you mean by structural, I think, is whether we just live with higher energy prices for a longer period of time.

[00:07:27] Michael Foggin: Absolutely. I personally don't see a way that we walk out of this with energy just moving back to where it was, a status quo. I think at the very least it's going to take quite a while to work through the backlog. I think there should then be a risk premium attached to that. I sort of feel like there should be something more priced in than has been so far but we are moving from social media headline to headline and it's very hard for the market to try and price that.

[00:07:59] Pamela Ritchie: Take us back to the beginning of the year, which seems like a very long time ago. It was actually literally to the day three months ago. The world was awash in perhaps taking a look at the disruptions from AI, or that's come through probably in the most recent month, certainly, the discussion of international trade, perhaps less of the US exceptionalism, that's more of an equity story, there was an international resurgence afoot and where was AI going to hit? Tell us a bit about how you walked into the year.

[00:08:31] Michael Foggin: We walked in wondering what could possibly upset the market. Yield seemed pretty attractive in the fixed income market. We felt like the economy is going to do pretty well, perhaps buoyed by some of the AI CapEx, also some fiscal spend from governments, not least Germany with a huge fiscal plan. It sort of felt like while credit spreads were particularly tight the disruption we were going to see was going to be limited, limited to certain areas and sectors, we can talk about that later, but it felt like credit spreads were rich but all-in yields were pretty attractive. The one thing that was sort of the big issue that was on people's mind was the amount of issuance that was going to come from hyperscalers.

[00:09:18] Pamela Ritchie: And it did come. I mean, we've seen a ton.

[00:09:21] Michael Foggin: Absolutely. The question about how the market was going to digest that amount of issuance sort of felt like worry number one. It's certainly not worry number one anymore but it's still there. The amount of issue that was done in 2025 was five times what was done in 2024. What's going to be done in 2026 will be at least double that. Numbers get up into the trillions and quite how the market digests that is a question.

[00:09:51] Pamela Ritchie: Is it oversimplifying to say that it's almost like a new, it's not a new asset class, it's fixed income and they're issuing bonds, but it's a certainly very new, large piece within the fixed income market that's having its first big test.

[00:10:07] Michael Foggin: What we're seeing is issuance from high quality issuers, bonds from high quality issuers, often longer dated, higher rated than the index, but can grow to be a significant portion of the index, bigger than, perhaps, banks or utilities. To have this new cohort of bonds which, perhaps, dealers and hedge funds and other participants can use as a beta, as a market barometer, it's almost like a pressure gauge of, well, I need to buy risk, I'll buy these bonds, I need to sell risk, I'll sell these bonds. We've had it in the past with other sectors like autos or telcos, they're sort of the bonds that people reach to because they're easy to trade, you can trade a large size in them, you can short them, so they become the barometer of the market. I feel that's where we may end up with these bonds. There's a lot of risk being added in, and I don't mean risk as in these are risky issuers, I mean longer dated bonds. When they move they move by multiple points and they can impact your portfolio.

[00:11:19] Pamela Ritchie: They're being issued on both sides of the Atlantic, certainly. We're seeing issues, especially by the hyperscalers, by the Mag-7, whatever you want to call it, on both sides, and as you say, very long dated. It's interesting to know ... we know where that money is going but the exposure within it, because we seem to still, and there always will be questions about this technological revolution, industrial revolution, whatever you want to call it, and just how well markets are priced for it right now. There may be some slides as we go along here. Just tell us about that risk and, basically, the AI disruption risk.

[00:11:58] Michael Foggin: When we think about how AI issuers will impact the fixed income market, I sort of think about it in three ways. I think about the issuance, this huge amount of bonds which will be coming to the market. They're not price insensitive but they certainly don't mind if spreads are a little bit wider. Then I think disruption risk, I think about issuers which may be in the portfolio or may be in the index or sectors where their business model is impacted by this new technology. Thirdly, I sort of think, which is really hard to comprehend sort of the macro impact of AI in the future and what that might mean for productivity, inflation, growth, et cetera, and then peripheral risk to that. We talked about the amount of issuance that there is. I do think that is a test for the market to see how the demand that we've seen throughout 2025 keeps up with this amount of issuance.

[00:13:01] Now, given what's happened in the last month and the higher yields I think demand will be pretty solid once we get some clarity on where the world is going. I think that demand [video cuts out] markets and they're much less exposed to the software and services that the US market has been. When I think about whose business model is disrupted it is issuers who are, perhaps, down capital structure and the policy structure, perhaps have issued loans, private credit or high yield. Software was a big part of those markets, and markets trying to struggle with winners and losers. Who is buying, whose business model is still solid, and whose perhaps needs to be re-rated? We've seen less of that in [indecipherable] markets.

[00:13:57] When you think about large sectors like utilities, [indecipherable] the winner with increased energy demands, banking, perhaps less impacted, business model isn't that easy to step into, insurance, real estate, et cetera. We're not seeing the whole market being impacted by AI. Therefore, it's sort of an idiosyncratic risk which you can manage within your portfolio. In the long run, what does AI mean to society? Well, it's a very big question, and how central banks manage to navigate through the increased productivity with potentially lower employment, et cetera, that's almost the story for further down the road. For now I feel like issuance and the idiosyncratic risk is what we need to focus on.

[00:14:45] Pamela Ritchie: Okay, and that's great. You're speaking here to Canadian investors and the discussion of where to go to avoid AI disruptions was very much the question a month ago before the war became the frontline story for sure. We'll talk more about that in a second because there's a lot to do with the energy for everyone. In the sense that if you were to take a look at a portfolio of bonds that may be more internationally focused you would probably have less exposure and therefore less risk to AI disruptions. Is that right?

[00:15:18] Michael Foggin: For sure, the BDCs, the business development [inaudible] that have struggled, there were definitely some winners in there but there's just less issuance in Europe. There's less software issuances in Europe. If you were to look at a broad portfolio you're going to have less exposure to that disruption in international. As always, I always preach that the more diversification the better. I don't think you need to call these sort of big directional macro calls, diversification will always be your friend.

[00:15:50] Pamela Ritchie: Let's go to rates, and we might even be able to put that within the sort of framework of diversification, because it appears that, perhaps, the Fed has more of an opening just because they're up higher in their rates right now, to decide what they want to do. Much of the rest of the world has finished their rate cutting cycle and is in a position where they were planning probably just to stay there [audio cuts out] would be hikes but not for a while. How much, I mean, it seems like that's entirely disruptive. You see movements constantly on this. Just take us through the rate story from your perspective.

[00:16:27] Michael Foggin: Away from gas and oil prices directly, I think the front end of government bond markets has been where it's really felt the most volatility, the most disruption. It's really a change from that [inaudible] hold to maybe we'll get a couple of cuts away, we think about the Fed or the Bank of England, to that's it, no more cuts, rate hikes. I think the market's priced in something like 18 rate hikes across developed markets. That's a huge shift in one month. We've seen a sell-off of something like 70, 80 basis points at the front end of the Euro market, 50, 60 at the [indecipherable] market, 50, 60 in euros, 30, 40 in dollars, big, big moves, big, big changes of expectations. That's because we've suddenly gone from inflation's under control to we don't know, we don't know.

[00:17:21] We don't know how long is this going to be, when is oil going to stop, how much is that going to flow through? Even if they decide it's over when is the gas going to come back online, when is the oil going to come back on line? It's a really uncertain picture so that front end has really, really moved. I think there was some crowded positioning in there. I think people liked the shape of the bond market, as I mentioned at the start. The outlook was pretty benign when we opened so a little bit of carry is always attractive, a little bit of a cut here and there looks pretty good. Inflation seemed to be going pretty well. I think there was some flushing out positioning there. Those moves have been pretty intense.

[00:18:02] Pamela Ritchie: Pretty intense, and I guess one of the questions that brings in sort of from the euro perspective, let's bring in the war. There have been many different voices about who started, who's going to join in in certain parts of the effort of this war to overall do lots of different things, one of them that we're basically talking about is to bring energy prices down. There have been fragmented responses to that. From the European perspective in terms of what they need to do to make sure that they're issuing in ways that help them and help the world and so on, what do they do? Is there an increase in demand for issuance for utilities, for instance, to get energy pulled in from everywhere? What do we see on that, what increases?

[00:18:52] Michael Foggin: Europe was really going under an energy transition already even prior to Russia, Ukraine. Europe was trying to greenify its economy. The Russian invasion of Ukraine really focused that and they need to get off non-domestic energy sources, and they need to ramp up renewables, pretty much what they were looking to do, or get up on different gas sources. That has been helpful to some degree but gas is still probably 25% of the energy demand in Europe, and a lot of that coming from the Middle East so huge amounts of disruption. Hence, we've seen the big moves in inflation expectations both in the UK and in Europe.

[00:19:39] I think this conflict, this war, whenever, however it ends, will just go to focus the minds even more that each country needs some form of energy security and they will continue to go down the path of renewable energy. I think that will lead to increased issuance from utilities, again, similar to the issuance that we talking about out of the AI companies in that it'll be high quality issuance, it'll be ... to some degree the utilities are even more systemic to the economy, is there some kind of implicit guarantee there from governments perhaps, I think it's an issuance that the market will be happy to take down but I don't see that story diminishing. I think that continues to go or continues to get increased issuances out of European utilities to deal with this.

[00:20:38] Pamela Ritchie: One of the big stories from last year was the increased spending of governments in Europe on defence. Canada is in a similar position. Was that a huge story last year? Are we going to continue to see pieces of that unfurl? Is it a significant part of your business? I mean, how does that fit?

[00:20:56] Michael Foggin: I think we continue to see that again. I think this will just go to intensify that need to increase spending. There was always a friction between government budgets and the ability to spend and can they put it off? A colleague of mine has just come back from Europe and he feels like that story's still well underway and we'll continue to see increased spending from all the European nations. There's always a question of home bias and where will they buy the defence from, can they do joint procurement, could you see Germany, France and Italy, Spain together buying, and if they do which defence company would they buy from, there is always a question of fragmentation in Europe.

[00:21:49] Pamela Ritchie: Do they need a euro bond to buy it with wherever they buy it from?

[00:21:53] Michael Foggin: Well, we continue to think about mutual issuance and I think all of these situations, be it the sovereign crisis, be it the war in Ukraine, now the next energy crisis, I think that just pushes Europe closer together. I think the hurdles to mutualization of debt just continue to be moved forward. I'm not going to say, yes, it's happening next year but I think the probability of it goes up every time we have one of these situations. Maybe you get a defence bank and they issue similar to the European investment bank, maybe we get a European defence bank. That was an idea that was being floated around at the moment. I think all of this just pushes cohesion within Europe, it pushes Europe closer together, which I think will be a positive thing.

[00:22:51] Pamela Ritchie: Tell us a little bit about risk appetite, maybe even contrasting it to the beginning of the year. I'm thinking of equity investors but you can expand this, once anyone gets sort of shaken through a big event and, I mean, there's still dip buyers in the equity market all over the place so it seems like maybe it isn't a huge event yet. But were it to be so, in theory, you would see risk appetite for bonds increase, no? Or an appetite for bonds increase, essentially.

[00:23:24] Michael Foggin: The demand for credit was insatiable in 2025 and up until the start of this conflict. The ingredients for that of attractive yields and questionable other areas to invest in remains, if anything, it's increased within yields going up. I think that demand will still be there. I think we would need to see, again, some clarity on where we're going on the geopolitical side before you see that bump back up again. When you think about individuals and what they want to do with their savings and you suddenly see a much more attractive fixed maturity bond I think the demand for that will continue to be high. I do sort of expect that if we have a de-escalation of this conflict, I would expect the fixed income demand to come back pretty quickly and to see what weakening we had in spreads retrace pretty quickly. The alternative to that is we don't get de-escalation, we either get a sustained disruption which then, as we discussed previously, really starts to hit input costs and therefore we [inaudible] the equity market, or we get some kind of escalation [inaudible].

[00:24:48] At that point I think everyone steps away and you get a gap [indecipherable] in risk assets. That would be the point of which you would reset. By a gap [indecipherable], I'm talking about credit spreads doubling and heading back to certainly not COVID levels but those sort of risk-off levels that we see every five years. I think we would have that now because we've seen so little volatility in credit spreads. People don't want to sell them so everyone's holding on to their credit. Equities are doing its thing, rates are doing its thing, vol is doing its thing, we haven't had the capitulation where people sell their credit yet. That's because they think any sort of normalization, the demand is going to outstrip supply again and you won't get the bonds back so people want to keep hold of them. The fundamentals of the underlying issue is all pretty solid so no one's thinking they're sitting on some problem child. It's the sort of continuation of disruption in the Straits of Hormuz, or an escalation, that can really cause that move wider in credit spreads. Then, as we've learned in the past, you have to be brave and buy. It'll be very uncertain period.

[00:26:10] Pamela Ritchie: It's been said for, I think, months now that there's only one way for credit spreads to go. Nobody knew what the catalyst would be because, of course, you don't. Is this the catalyst?

[00:26:22] Michael Foggin: We've seen probably in US and Europe, probably a 20% widening in credit spreads. To put that in perspective, US credit spreads have gone from their first percentile, as in as tight as they can be, to their 10th percentile. We're not near the median, we're not cheap — or 20th maybe. Similarly for Europe we've probably gone from 10th to 30th. We haven't got to a point where you can look at credit spreads and go, oh, that's cheap, I should be getting neutral there. The supply-demand imbalance that's been there remains, holding them very tight so I don't think that's played out yet.

[00:27:10] Pamela Ritchie: What do you think about the voices of central bankers right now? This is more sort of TMZ for people who trade bonds. What do you say about some of the comments coming out from central bank? We are hearing things like we're watching stagflation concerns very carefully, there's a lot of comment and a lot of talk that could or could not be useful, I would imagine. I'm just curious what you think.

[00:27:39] Michael Foggin: It's a tough place to be right now. We have portfolios to manage and peoples' assets to oversee but we can react on a daily basis and we can mitigate risks and we can get to neutral. We can have honest conversations with our clients about we don't know what's going to happen but these are the risks that we think you're facing. It's harder for a central bank when they can cause the issue, they can create more volatility if they start saying, well, that's it, inflation is here to stay and we're going to raise rates. That's not their job to create profitability. Sort of erring towards the wait and see side of it is essentially what they have to do. They have to take on board the data they're getting, which is always backward looking, and the market is forward looking so hence the market's priced in lots of rate hikes and central banks need to say, well, the last data we had said that we were fine, what do you want me to say? It's a tricky situation. The market is reading in rate hikes, not status quo.

[00:28:55] Pamela Ritchie: Just to sort of close out take us through this a little bit. The diversification in a global bond setting helps with sort of that discussion of what is exposed to AI, because global bonds are just simply less exposed and there's a few reasons for that. Then we have the concern about where rates go, rate risk, but ultimately sort of the moment that you will take us through, or you would take investors through, to step in when it looks like jaws are opening in the credit markets, which is a scary moment, actually. For the investor who wants to sort of enter what is this moment of diversification like?

[00:29:35] Michael Foggin: The move we've seen higher in yields means that fixed income has, by definition, become more attractive. The uncertainty that we're seeing in other asset classes and volatility makes some sense to me. Now, I always think it's a good time to diversify but when you've seen an underperformance of international rates versus US rates I think that's the story that now is a better time to diversify. I find it hard to argue for a credit-heavy strategy when credit spreads are still at these tight levels. A diversified portfolio that allows the manager to add risk when they see those opportunities is certainly something that I think makes sense. The ability for your manager to dial up risk quickly is probably more useful than then to try and do it very quickly by an ETF or something on your own. The moves, as we saw in Liberation Day, I think the sell-off lasted about four hours and then you couldn't buy the bonds anymore. You have to be quick.

[00:30:48] I'm not saying that's the situation that we're in here. This does seem to be a little more deep-seated. We're running a portfolio which is pretty close to home on credit risk with a little bit of a tilt duration, and the liquidity to add the risk when we see that capitulation. The one thing about credit spreads is that they do overreact. At the moment they're overreacting by staying too calm, and then we'll see them overreact by overshooting on the other side when they feel like there's doom and gloom coming. We saw that in 2022. That's an opportunity for active managers to then buy selectively the right bonds that are being sold by, perhaps, other managers.

[00:31:38] Pamela Ritchie: Do you see the next while being a risky time, every indicator when you're looking at MOVE, VIX, anything, it's going to be a volatile time?

[00:31:50] Michael Foggin: I do feel that way. From the start of the year when we were struggling to see what was going to upset the market, now I sort of wonder what's going to calm the market. I feel the situation in the Middle East is not one that we can just have a sign-off and tick and move on from. The disruption is there, it's going to be with us for a while. Those high energy prices feeding through the market are going to take a while to digest. While they're doing that there will be volatility in asset classes.

[00:32:23] Pamela Ritchie: Interesting times [indecipherable] bonds. Thank you so much, Mike Foggin, for taking us through that. We wish you very well and good afternoon to you.

[00:32:31] Michael Foggin: Well, thank you very much. Good to see you again.

[00:32:33] Pamela Ritchie: Good to see you again. That's Mike Foggin joining us live from London, taking you through the global bond picture, ultimately, that discussion of diversification. Very different story to some of the exposures there. Coming up on the show tomorrow, Cameron Chamberlain, Director of Portfolio Solutions, and Paul Aulicino, he is Director of Portfolio Strategists, they're going to be sharing what they're hearing from advisors, the trends they're seeing in portfolios, and discuss Fidelity Portfolio Intelligence. This is a portfolio analytics, an optimization tool to help advisors align investment portfolios to clients' goals. Portfolio strategist, Benjamin Romulus, he'll be joining us first at 10:30, this is all tomorrow, that's Eastern time for a French language webcast, same topic.

[00:33:16] On Thursday institutional portfolio manager Scott Mensi, he will be breaking down how the latest news is influencing income-focused asset classes. He'll highlight where he's finding opportunity and outline the positioning of the Fidelity Tactical High Income Fund, we'll hear more on that side of things. That webcast will be presented in English with live French audio interpretation.

[00:33:36] We'll be off the air for Friday, Good Friday, but do join us on Monday. Institutional portfolio manager, Ilan Kolet, he'll kick off the trading week for us with what he and the Global Asset Allocation team are following. All of that ahead. That webcast next Monday will feature French live audio interpretation. We're glad you could join us here today. We'll see you soon. I'm Pamela Ritchie.