Global liquidity supports financial markets – corporate and convertible bonds poised to benefit

An environment characterised by rising liquidity, moderate economic growth and contained inflation continues to underpin risk assets. While the looming increase in the US debt ceiling poses a potential threat, the current investment backdrop remains constructive. Corporate and convertible bonds stand out as particularly well-positioned.

The global macroeconomic setting is currently reminiscent of a classic “Goldilocks” scenario – not too hot, not too cold – with moderate growth, manageable inflation and an expansion in liquidity. “It’s a highly favourable constellation,” says Beat Thoma, Chief Investment Officer at Fisch Asset Management. “However, from August onwards, this could change quite materially.”

Liquidity remains the principal driver of economic momentum and appetite for risk assets. Following a sharp contraction in global M2 money supply in Q4 2024 – which precipitated a correction in equity markets – conditions have been steadily improving, Thoma notes. In tandem, equities and other risky assets, such as corporate bonds, have regained traction.

Despite the Fed’s ongoing quantitative tightening, commercial banks continue to hold rising reserves with the central bank. This reflects the persistence of money creation, which in turn is contributing to broader monetary expansion.

While greater liquidity could eventually reignite inflationary pressures, expectations have remained anchored for now. Temporary upward pressures – for instance, those stemming from tariffs introduced during the Trump administration – have since abated. “The situation remains under control, at least for the time being,” Thoma observes. This remains true even against a backdrop of softening economic activity in both the US and Europe, though without signs of an impending downturn. The weaker growth, in effect, helps offset the inflationary impulse from rising liquidity.

The looming risk posed by US government debt
This favourable alignment may soon come under strain, however. A decision by the US government to raise its debt ceiling by a total of roughly USD1 trillion – anticipated in August – could prompt a sizeable wave of Treasury issuance. The result would likely be a meaningful drain on market liquidity, as capital is absorbed by sovereign debt markets and diverted away from risk assets.

Such a development would also increase the likelihood of investors demanding higher risk premia on US Treasuries. As government borrowing spirals higher, each round of debt issuance will increasingly need to be financed by further borrowing – at ever more elevated interest rates. “It’s a ticking time bomb,” Thoma cautions. Nevertheless, he underscores the likelihood that the Fed would intervene should severe market dislocations arise.

With this in mind, investors should monitor the US dollar closely. A weakening of the greenback – particularly against the Japanese yen or the euro – would signal trouble.

By contrast, geopolitical risks remain a secondary concern, in Thoma’s view. “Markets have a tendency to shrug off political shocks,” he notes, citing the recent Israel-Iran tensions, which were quickly digested by financial markets.

Corporate fundamentals as robust as they’ve been in years
As sovereign debt burdens and interest costs continue to mount, corporate balance sheets are stronger than they have been in years. “Credit quality has improved significantly in recent times,” notes Oliver Reinhard, Head of Developed Markets at Fisch Asset Management – particularly within the investment-grade segment. According to the Bank of America Global Fund Manager Survey, investor sentiment towards corporate fundamentals is at its most constructive since 2016.

“Revenues and profits are on the rise, while debt growth and shareholder distributions have moderated,” says Reinhard. This has created an attractive environment for credit investors.

These stronger fundamentals are also being recognised by rating agencies. Within US dollar-denominated investment-grade debt, the proportion of bonds rated BBB has declined from its 2018 peak. Moreover, the share of bonds rated BBB-, i.e. the lowest tier of investment grade, now sits at just 8.6 per cent, a record low.

Favourable technicals amid scarce supply

Beyond fundamentals, technical factors are also lending support. Demand for corporate bonds remains robust, while supply is limited. “We anticipate that net new issuance of US dollar investment-grade debt – gross issuance minus redemptions – will be materially lower this year compared with 2024,” Reinhard explains.

At the same time, interest income from such bonds is rising. Investment banks forecast USD 461 billion in coupon payments for 2025 – equivalent to USD 38 billion per month. This would represent a 9% increase on 2024 levels and a 32% rise versus 2023.

Historically, corporate bond yields have proven to be a reliable predictor of total returns earned over the following years. “Currently, US dollar-denominated investment-grade bonds are yielding 5.1% – offering attractive prospects,” Reinhard notes. From a sectoral perspective, he sees particular value in financials, telecoms and healthcare.

Convertible bonds: poised for a resurgence
Another segment garnering renewed interest is convertible bonds. These instruments enable investors to participate in growth sectors, while mitigating associated volatility. “Companies issuing convertibles often demonstrate strong earnings momentum,” says Ute Heyward, Senior Portfolio Manager at Fisch Asset Management. “On average, issuers are forecasting earnings growth of 18.6% over the coming years – nearly 70% above the broader equity market.”

With interest rates elevated, many corporates are increasingly turning to convertibles as a more cost-effective means of raising capital. “Coupons on convertibles are generally lower than on traditional debt,” Heyward explains. “In return, investors gain exposure to the underlying equity upside.”

Convertibles offer a structurally asymmetric return profile. “In rising markets, they behave more like equities, while in downturns, their bond-like characteristics provide a certain cushioning effect,” says Heyward. This dynamic allows investors to access growth, while tempering equity market risk.

Broadening universe offers choice for investors
Encouragingly, issuance is becoming more diverse – across sectors and company sizes – enabling greater portfolio diversification. Furthermore, valuations remain attractive: convertibles offer growth exposure at a discount. “The expected price/earnings-to-growth (PEG) ratio is currently offered at a more than 20% discount compared to the broader equity market. This means that investors can access growth at a more reasonable price,” Heyward highlights.

Such valuation advantages have historically paved the way for outperformance. “In periods when convertibles have traded at these kinds of discounts, they’ve tended to outperform equities,” Heyward notes. “We may well see that pattern repeated this year.”