Payden Global Government Bond Index Fund

February was characterised by shifting interest rate expectations and renewed volatility across global fixed-income bond markets. In the US, the policy debate remained dominated by whether inflation had slowed enough for the Federal Reserve (Fed) to resume rate cuts. In Europe, the macroeconomic narrative was clearer: inflation continued to moderate and growth data proved steadier than expected. As a result, the European Central Bank (ECB) kept rates unchanged, though financial markets still anticipate rate cuts over the medium term.

In the US, markets were driven by the tension between still-elevated inflation and evidence that economic activity is slowing. Consumer spending remained relatively strong, particularly in the services sector, whilst manufacturing surveys continued to signal subdued conditions. The labour market showed further signs of cooling: layoffs remained low but hiring slowed and payroll growth moderated, consistent with a gradual rebalancing of labour demand. Inflation continued to ease overall, although progress varied across different categories, reinforcing the view that the return to the Fed’s inflation target is unlikely to be smooth. Markets also paid attention to political developments, including discussion about the future leadership of the Fed ahead of the scheduled end of Chair Jerome Powell’s term in May 2026, which has kept investors focused on the longer-term direction of monetary policy. By the end of the month, The S&P 500 had fallen 0.87%, whilst the yield on the 10-year US Treasury stood at 3.94%.

Across the Atlantic, the ECB left interest rates unchanged at its February meeting, emphasising that inflation should stabilise at its 2% target over the medium term, despite risks from geopolitical tensions and trade uncertainty. Preliminary data showed euro area inflation slightly below the ECB’s target, reinforcing expectations that the ECB is nearing the end of its rate-cutting cycle and is unlikely to reduce rates further this year without a sharper economic slowdown. Economic indicators pointed to subdued growth across the euro area, with Germany’s economy remaining fragile, and bank lending growth was weak, keeping attention on when the ECB might eventually begin easing policy again. By the end of the month, yields on 10-year German bunds stood at 2.64% and 10-year UK gilt yields were at 4.23%.

The conflict in Iran has moved to the forefront of investors’ attention since the end of February, and market sentiment in the coming weeks will likely be closely tied to developments in the Middle East. At this stage, uncertainty remains very high regarding the potential duration, scale, and broader implications of the conflict, adding another layer of complexity to an already challenging macroeconomic environment. The primary macroeconomic risk stems from the possibility of a prolonged disruption to energy flows through the Strait of Hormuz, a critical chokepoint through which roughly 20% of global oil supply transits. Markets experienced significant volatility in the first week of March, with some of the moves amplified by the unwinding of crowded positions. The magnitude of the reaction has varied across asset classes. Government bond yields have moved sharply, whilst credit markets have remained relatively orderly thus far.

Notwithstanding the risks around the conflict, our macroeconomic outlook remains relatively optimistic with risks tilted to the downside. The US economy remains central to our global outlook in 2026. We believe the current divergence between strong GDP growth and weakening labour markets in the US is unusual and unlikely to persist. In our view, the US economy faces a binary path: either reaccelerating as technology-driven productivity gains take hold or slipping into recession if labour market softness begins to weigh more broadly on economic activity. Regardless of the outcome, US inflation is expected to continue moderating. This disinflationary trend, combined with labour-market weakness, should allow the Fed to continue easing policy towards neutral and potentially beyond. Stickier inflation remains a risk to this central view, a risk that has recently increased given the developments in the Middle East.

Outside the US, most developed economies appear relatively resilient, supported by moderate economic growth, declining inflation, and accommodating or easing monetary policy. Japan stands as an exception, where gradual policy tightening is expected to continue. Moderating inflation and range-bound inflation expectations have historically been associated with a negative correlation between interest rates and risk assets. With economic growth facing more downside risks, we believe portfolios with a balanced and diversified allocation between duration and credit risk should be better positioned to navigate the uncertainty and range of potential outcomes in 2026. The conflict in Iran is a direct threat to our inflation view, and we remain mindful of these risks for the time being. Greater dispersion across and within sectors emphasises the need for diversification and strong bottom-up fundamental analysis.

Despite the uncertain economic backdrop, credit valuations remain on the most expensive end of the historical range, even as corporate fundamentals appear relatively healthy. In this environment, we prefer to distribute risk in our portfolios in a more balanced manner across duration and credit. Consistent with our outlook, we maintain modest overweight positions in higher-quality credit sectors, including investment-grade corporates and select high-quality securitised assets.

Given the ongoing concerns around economic growth, we also favour greater exposure to duration, positioning portfolios to benefit from further declines in interest rates. Within this allocation, we prefer intermediate-maturity US Treasuries and select emerging-market sovereign bonds. We are also positioned to benefit if the gap between short-term and long-term interest rates grows wider (a "steepening" yield curve), especially in the US and Germany, which we believe could provide some protection in an economic slowdown or if fiscal policies become more expansionary. In our currency strategy, we hold an underweight position in the US dollar, although less pronounced than earlier in 2025. This positioning is expressed against a diversified basket of developed and emerging-market currencies, such as the euro, the Japanese yen, and the Brazilian real.