Welcome to Cavalen Asset Management’s inaugural blog. Our goal is to provide insightful perspectives on bond markets—grounded in experience, disciplined in analysis, and always focused on value. Given this is our first post, it is important to establish not just where we see opportunity in markets today, but also how we think about investing in bonds more broadly.
Investment Philosophy: The Intersection of Macro, Sentiment, and Positioning
Markets are inherently forward-looking, and yet they often get ahead of themselves. While macroeconomic fundamentals provide the foundation for investment decisions, it is sentiment and positioning that frequently drive the most attractive opportunities.
It is not enough to simply observe that central banks are cutting rates or that inflation is trending lower. What matters is whether these developments are expected or unexpected by the market, and whether positioning already reflects the likely outcome. Too often, investors rely on macroeconomic forecasting as if it were a science, when in reality, markets tend to behave in ways that surprise the consensus.
The Current Macro Landscape
The global rate cycle is in transition. The Bank of England’s recent rate cut confirms that major central banks are shifting toward easing, but each is doing so with a different level of urgency. The ECB has indicated that its neutral rate is likely around 1.75%–2.25%, meaning it may be only two or three rate cuts away from pausing. Meanwhile, the Federal Reserve remains cautious, and Friday’s US payrolls report reinforces that view. While the headline number was slightly weaker, revisions to prior months were strong, the unemployment rate ticked lower, and wage growth was robust. In other words, the Fed has little incentive to move aggressively on rate cuts in the near term.
Markets are now fully pricing two more BOE cuts and at least three for the ECB this year, while the Fed is expected to begin easing later, with September now seen as the most likely starting point. However, there remains a significant risk that central banks do not move as quickly as markets hope, which could put upward pressure on yields in the near term. At the same time, if the economy slows more than expected, rate cuts could accelerate.
Bank of England Inflation Projections:
Source: Bank of England Inflation Report February 2025
The BoE’s projections indicate that inflation is expected to return to target, but the path remains uncertain. Any deviation from this trajectory could influence market expectations for future rate cuts.
Where Do Bonds Stand in This Environment?
This divergence in global rate expectations provides both risks and opportunities in fixed income.
- Government Bonds: With the Fed staying patient, US Treasuries may not yet be positioned for a significant rally unless economic data weakens more materially. While the ECB and BOE appear to be in easing mode, European bonds have already priced further rate cuts in, and yields may need to adjust higher to create more attractive opportunity in the near term.
- Credit Markets: Credit spreads remain tight, reflecting confidence in corporate fundamentals. But with growth faltering in parts of the global economy, there is little room for error. Investors chasing yield should remain disciplined, as overconfidence in corporate resilience has led to sharp repricings in past cycles.
- FX Markets: The dollar has remained supported by the Fed’s relative hawkishness, while the pound has underperformed most G10 currencies this year. If the divergence in rate expectations persists or grows, this could extend further. But market positioning and tariff risk may not assist further US dollar gains.
- ECB Neutral Rate Estimates:
The ECB’s estimate of the neutral rate suggests the rate-cutting cycle may be nearing an end. If inflation proves sticky, the market could face an adjustment in expectations.
The Role of Sentiment and Positioning
At Cavalen, we do not invest based on macroeconomic forecasts alone. Instead, we seek to understand how expectations, sentiment, and positioning influence price action. This is particularly important at inflection points in the market cycle—such as today—when investors are adjusting to a world of slower growth, shifting central bank policies, and new geopolitical risks.
A prime example of this was early November 2023, when bond market sentiment was extremely bearish on US Treasuries. The market had built up crowded short positioning in anticipation of higher yields, but when softer inflation data emerged, a rapid repositioning occurred—leading to a sharp rally. This highlights how sentiment extremes create opportunities, and we believe current market conditions could set up similar dislocations later in 2025.
Key Risks Investors May Be Underestimating
- Tariff Uncertainty and Growth/Inflation Risk: The aggressive tariff policies currently being pursued by the new US administration introduce a major source of uncertainty for global markets. Tariffs have the potential to drive up inflation, and drastically reduce growth, particularly if supply chains are disrupted or retaliatory measures escalate. This could challenge central banks' ability to cut rates as quickly as expected or necessary for growth and could lead to higher term premiums in bond markets due to rising uncertainty. In FX markets, tariffs could lead to heightened volatility, with outcomes uncertain—previous USD strength could reverse sharply if trade tensions escalate, while emerging market currencies could come under pressure.
- Rate Cut Expectations May Be Overdone: Markets are currently pricing multiple rate cuts in 2024, but with the latest payrolls data showing strong wage growth, inflation risks remain. If central banks move more slowly than expected, particularly in Europe, yields could rise in the near term instead of falling.
- Tight Credit Spreads Leave Little Room for Error: Corporate credit spreads remain extremely tight, suggesting that investors are confident in corporate resilience. However, we believe markets may be underpricing volatility, which should provide more opportunities later in the year as economic uncertainty evolves. If economic weakness emerges, spreads could widen sharply, catching some investors off guard, but potentially providing a more attractive buying opportunity for more patient investors, such as ourselves.
- Final Thoughts
As we move deeper into 2025, our approach remains unchanged: conviction-driven, value-focused, and guided by sentiment and positioning as much as macro fundamentals.
This is just the beginning of our insights at Cavalen. In the coming months, we will continue to explore key developments in global bond markets, central bank policy, and shifting macro conditions—always with an emphasis on understanding where value and opportunity truly lie.
Craig Veysey
Cavalen Asset Management