Fiscal policy has once again taken centre stage as key Developed Market (DM) countries embark on expansionary paths, even as many Emerging Market (EM) nations pursue a more prudent approach.
In the US, the Congressional watchdog has stated that President Donald Trump’s “big beautiful” bill would add $2.4 trillion to the budget deficit by 2034. The bill seeks to extend Trump’s 2017 tax cuts and fulfil his campaign promises to eliminate taxes on tips and overtime, in addition to boosting spending on border security and defence. At the same time, some expenditure cuts are envisaged, particularly to Medicaid.
The Department of Government Efficiency (DOGE), established to curtail government spending, has had only mixed results, dashing hopes of a radical reset in US fiscal policy. Billionaire Elon Musk, who headed the department since its inception earlier this year, has exited the government and has sharply criticised the administration’s spending plan.
Fiscal indiscipline is now a problem in DM, not EM
Government debt/GDP, EM versus DM
Everything is not hunky-dory on the fiscal front in Europe either. Changing geopolitical contours, exacerbated by Trump’s ``America First’’ policy, have raised doubts about the strength of the transatlantic defence alliance that’s endured since World War II. This has prompted Germany to announce a EU1 trillion spending push to strengthen its military and boost infrastructure.
Under the German plan, a newly created infrastructure fund is allowed to borrow up to EU500 billion over 12 years. Germany has also relaxed strict debt rules, exempting any defence spending exceeding 1% of GDP from the borrowing cap. In addition, 16 federal states are allowed to borrow as much as 0.35% of GDP.
Germany’s move could have wider ramifications for the rest of Europe given its importance as the continent’s largest economy and its influence in the European Union. While Germany’s relatively low debt-to-GDP ratio means that it has room to spend more, that’s not the case for other major European economies such as France, Italy and the UK, where the debt levels exceed the size of their economies.
While the developed world is struggling to contain their deficits and debt levels, Argentina eked out a surplus last year by embarking on a sweeping austerity drive, sharply reducing government workforce and undertaking reforms such as scrapping its fixed exchange rate policy as part of a $20 billion IMF loan deal.
All these developments mean the spotlight has now decisively shifted to fiscal policy from monetary policy. This is in contrast to the 2022-2024 period when central banks aggressively tightened their policies to tamp down a spike in inflation caused by a boost in government spending during Covid to underpin demand in the economy.
Inflation has since eased considerably (though it remains above central bank targets), and interest rates have normalised, providing attractive real rates in many developed markets. Yield curves have steepened, with fiscal expansion pressuring long-end yields in particular.
The current environment is markedly different from the years following the Global Financial Crisis (GFC), when ultra loose monetary policy pushed a sizeable portion of the bond universe into negative territory. Today, yields are hovering near the highest level since the GFC, enhancing the attractiveness of government bonds. On the other hand, credit spreads have stayed tight despite risks of a blow out, highlighting that this is an optimal time to reallocate to “safer” government bonds.
The good news
Income is back in government bonds
Bloomberg Global Aggregate Treasuries Index - Yield to Maturity - last 20 years
Trump’s back-and-forth on tariffs is another theme that’s added to the elevated anxiety and uncertainty of investors as markets weigh the effect of the import tax on inflation and growth. So far, the US has signed a pact with only the UK, with talks still underway with major trading partners such as China and the European Union. We believe differentiated tariff rates across trading partners will lead to varied asset performance by country.
Geopolitical risks further compound market volatility. The flare up in tensions in the Middle East due to the Israel-Iran conflict as well as the raging Ukraine-Russia war have heightened uncertainty in the wider market. Simmering tensions with China over Taiwan could be another key flashpoint.
A new regime of heightened macro volatility
Active approach to government bond investing is optimal
MOVE Index
Diverging fiscal policies, tariff-related uncertainty and geopolitical turbulence have all contributed to elevated volatility in the bond market. The divergence in spending by governments makes active approach to government bond investing attractive as strategies such as our Jupiter Global Government Bond Active ETF (GOVE) are well-positioned to identify opportunities across yield curves and geographies. The current high dispersion in returns between sovereign bond markets illustrates the benefits of a globally diversified government bond portfolio. In this environment, we believe diversifying within DM sovereign bonds prudently investing in select EM debt offers a compelling investment strategy.
Fund specific Risks
- Currency (FX) Risk - The Fund can be exposed to different currencies and movements in foreign exchange rates can cause the value of investments to fall as well as rise.
- Share Class Hedging Risk - The share class hedging process can cause the value of investments to fall due to market movements, rebalancing considerations and, in extreme circumstances, default by the counterparty providing the hedging contract.
- Interest Rate Risk - The fund can invest in assets whose value is sensitive to changes in interest rates (for example bonds) meaning that the value of these investments may fluctuate significantly with movement in interest rates e.g. the value of a bond tends to decrease when interest rates rise.
- Pricing Risk - Price movements in financial assets mean the value of assets can fall as well as rise, with this risk typically amplified in more volatile market conditions.
- Emerging Markets Risk - Emerging markets are potentially associated with higher levels of political risk and lower levels of legal protection relative to developed markets. These attributes may negatively impact asset prices.
- Contingent convertible bonds - The fund may invest in contingent convertible bonds. These instruments may experience material losses based on certain trigger events. Specifically these triggers may result in a partial or total loss of value, or the investments may be converted into equity, both of which are likely to entail significant losses.
- Credit Risk - The issuer of a bond or a similar investment within the fund may not pay income or repay capital to the Fund when due.
- Derivative risk - the Fund may use derivatives to generate returns and/or to reduce costs and the overall risk of the Fund. Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment.
- Counterparty Default Risk - The risk of losses due to the default of a counterparty on a derivatives contract or a custodian that is safeguarding the fund's assets.
- Sub investment grade bonds - The fund may invest a significant portion of its assets in securities which are those rated below investment grade by a credit rating agency. They are considered to have a greater risk of loss of capital or failing to meet their income payment obligations than higher rated investment grade bonds
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
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