
Markets and Economy Market experts take a deep dive into DeepSeek
Our experts address the critical questions that arose following the news of DeepSeek’s artificial intelligence model and the market’s volatile reaction.
With a slower growth outlook, we’d expect the Federal Reserve to look through tariffs' inflationary impact and let rates go lower.
With so much uncertainty, especially around growth, we think bonds negative correlation to stocks will continue.
While the lower-income end consumer markets are squeezed, it shouldn’t impact the overall economy or credit spreads.
Investment grade bonds are up 2.34% this year, with much of its solid performance driven by a rally in intermediate yields.1 There's been a lot going on under the hood. Here’s our insights about the various market drivers year to date, and where we think investment grade is headed in the coming months.
Craig: Let’s start with rates since they have been the biggest driver of returns this year. They moved late last year, reflecting uncertainty over what the new Trump administration’s policies could mean for inflation. What’s your view on rates in the coming months?
Matt: The market started the year concerned about inflation driven by animal spirits (emotions) as the Trump administration was sworn in. We had a hot Consumer Price Index (CPI) print in January, but inflation has slowed and the focus has shifted toward future growth. Markets are concerned about tariffs and their potential negative impact on the economy. There’s also concern around immigration policy, which could be growth-negative. Whether tariffs are inflationary, or just one-time price resets, is debatable, but the Federal Reserve (Fed) will likely need to navigate the price impacts of tariffs at the same time that the US economy may be slowing. Given a slower growth outlook, we’d expect the Fed to look through the inflationary impact of tariffs, allowing rates to go lower.
Craig: How have earnings been for industrials? Is credit expansion continuing to drive growth?
Matt: We've seen strong earnings from industrials this year. Utilities have had a somewhat more mixed performance. But if you look at traditional US industrials, they’ve done well.2 The outlook going forward may be more negative or mixed, however. As earnings reports have come out, a lot of companies have beat expectations, but guided forward expectations were down, particularly for consumer-related companies.
Corporate balance sheets are still in good shape overall. There has been a fair amount of issuance in the investment grade market and some in high yield, but it's been well received. Some companies are taking on debt to pay down debt coming due from previous years, but they appear to be aimed at not levering up.
Craig: Bonds have been negatively correlated to stocks in recent selloffs, such as January’s DeepSeek-related one. What did bonds do during the March stock correction?
Todd: Bonds performed as expected — they were inversely correlated to stocks in these risk-off events. Whenever we’ve had a selloff this year, interest rates have fallen and bonds have rallied. That’s exactly why they may be beneficial in a mix of assets, in our view, for that inverse correlation. With so much uncertainty, especially around growth, we think this negative correlation will continue throughout the rest of the year. Also, many investors have been yield buyers. Upward corrections in yields have the potential to draw buyers back into the market, so bonds could perform well in different situations.
Craig: Investment grade rating upgrades have outstripped downgrades, but Celanase and Nissan were downgraded to high yield. Do you think it’s symptomatic of broader trends or are they idiosyncratic? Also, are there any changes to your bull and bear cases for credit spreads this year?
Todd: The ratio of investment grade credit upgrades to downgrades has risen sharply since the 2020 COVID-19 crisis, to a record 4.7 in 2024.3 Celanese, a global chemical company, and the carmaker Nissan are two one-off situations, in our view, because the companies were poorly run and the downgrades weren’t related to broader fundamental concerns, such as tariffs.
At the end of the day, we still expect more upgrades than downgrades going forward. Of course, if tariffs cause economic activity to slow sharply in the second half of the year, fundamentals could be more challenged, but that isn’t our base case.
For spread expectations, our bull case (15%-20% probability) was for a 55 basis point spread on the investment grade index. That was predicated on a high all-in yield of 4.5% or more on the 10-year Treasury, but not exceeding 5%. In other words, our bull case was dependent on being in the sweet spot of the high 4% level in rates, but without the fear of blowing through the high end of the recent trading range, which might cause panic.
We believed that the high end of the range would likely attract yield-based buyers, such as insurance companies, annuities, and pension plans. Now that we’re trading in the low 4% range on the 10-year Treasury, we’re less optimistic about how much tighter spreads can go.
Our bear case was a widening to around a 120 basis points spread on the index, which has a very small probability, in our view. A key tail risk would be a serious policy misstep, for example. But though there is much volatility and noise around policy, we don't believe economic outcomes will be drastically negative.
Craig: We’ve had spirited debates about the consumer lately. It seems like there’s some softness at the lower end of the consumer spectrum, which has yet to show up in the macro numbers. Have you made any portfolio positioning shifts, or are you thinking about any new risks based on divergent consumer strength and behavior?
Matt: We recently did a deep dive on the consumer. The general conclusion was that there are consumer market segments that are getting squeezed, especially on the lower income end. Is the squeeze big enough to have an impact on the trajectory of the economy and potentially widen credit spreads? We don't think so. We expect some economic slowing this year, so we want to be cautious on certain areas of the economy that could be impacted, like subprime auto and credit card loans. The auto companies could also be susceptible, including foreign ones that could be hit by tariffs. So, we’ve been cautious on areas that could be impacted by a pullback from lower-end consumers. But we don't expect the current consumer dynamics to change the direction of gross domestic product (GDP) or the overall economy at this juncture.
Source: Bloomberg US Credit Index. The index is up 2.34%, Jan. 1, 2025 to March 21, 2025.
Source: According to Factset, 78% of S&P 500 industrials companies reported earnings that were above market expectations in Q4 2024. Utilities also beat expectations in several cases, but only 48% reported beats versus consensus estimates, so the results were more mixed. Factset, Earnings Insight as of March 20, 2025.
Source: JP Morgan, JPM Daily Credit Strategy & CDS/CDX am update, Jan. 7, 2025.
Our experts address the critical questions that arose following the news of DeepSeek’s artificial intelligence model and the market’s volatile reaction.
With the Fed poised to continue cutting rates, investors have the all-clear signal to move off the sidelines, perhaps into intermediate term bonds.
If our soft-landing base case plays out, our investment experts see credit and fixed income opportunities ahead and believe they may be able to achieve high single-digit yearly returns. Read why.
Important information
NA4350644
Image: SpicyTruffel / Getty
All investing involves risk, including the risk of loss.
Past performance does not guarantee future results.
Investments cannot be made directly in an index.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
A basis point is one-hundredth of a percentage point.
The Bloomberg US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate, and government-related bond markets.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Correlation is the degree to which two investments have historically moved in relation to each other.
The Consumer Price Index (CPI) measures the change in consumer prices and is a commonly cited measure of inflation.
A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO) of the creditworthiness of an issuer with respect to debt obligations, including specific securities, money market instruments, or other debts.
Credit risk is the risk of default on a debt that may arise from a borrower or issuer of bonds failing to make required payments.
Credit spread is the difference in yield between bonds of similar maturity but with different credit quality.
Gross domestic product (GDP) is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time.
High yield bonds, or junk bonds, involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.
Idiosyncratic developments refer to unique events that do not affect an entire market or portfolio.
Inflation is the rate at which the general price level for goods and services is increasing.
Spread represents the difference between two values or asset returns.
The opinions referenced above are those of the author as of March 25, 2025. These comments should not be construed as recommendations but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties, and assumptions; there can be no assurance that actual results will not differ materially from expectations.
This link takes you to a site not affiliated with Invesco. The site is for informational purposes only. Invesco does not guarantee nor take any responsibility for any of the content.