Q: After all the volatility we have seen this year, where do we currently stand in fixed income?
The stage is set for less volatile times in bond markets, characterised by inflation rates still above target but getting closer to it, and the US Federal Reserve (Fed) resuming its rate-cutting cycle. Additionally, strong demand, limited new issuance, and robust corporate fundamentals are underpinning market stability. Hence, despite the recent tightening in credit spreads, corporate debt remains an attractive option for income-seeking investors, offering the potential for positive excess returns in a relatively stable environment.
Q: With interest rates set to drop in the US, what should investors be mindful of?
As concerns over tariffs and fiscal and monetary policies subside, a more stable environment is emerging for global bond investors. Our Fixed Income Research team expects that 10-year US Treasury yields will trade within a lower range of 3.5% to 4.5%, while the yield curve will continue to steepen due to lower Fed policy rates. To take advantage of this evolving yield landscape, our strategists recommend focusing on corporate bonds that provide regular income through coupon payments, while extending duration to the upper end of the intermediate target range of five to seven years. This approach enables investors to capture capital gains by ‘rolling down the upward-sloping yield curve’, i.e. investors benefit from the capital gain created by the natural fall in a bond’s yield as it approaches maturity, as well as by collecting (‘clipping’) still attractive corporate bond coupons. Thus, despite admittedly narrow spreads, the total returns on investment, which include both coupon payments and capital appreciation, remain attractive.
Q: Can you say more about which segments of the fixed income market investors should focus on?
Low-investment-grade and emerging market hard-currency bonds, in particular, offer compelling return expectations coupled with low default risk. This is reflected in historically low default rates and in an equally promising outlook. So far this year, there have been 145 upgrades vs 38 downgrades within the investment-grade segment in the US, which is echoed in Europe.
From a regional perspective, while USD corporate markets remain dominant, global capital is partly rebalancing away from the US. In the wake of the geopolitical tensions, US domestic policy shifts, and USD weakness during the first half of the year, the case for geographic diversification is becoming harder to ignore, and is, in fact, a critical component in our investment strategy.
Find out more about the current investment environment in our Market Outlook End-Year 2025.
Q: What are the three key takeaways for investors?
- In Europe, corporate bonds are in a sweet spot, benefiting from lower inflation, improving growth prospects, and strong foreign demand.
- Meanwhile, emerging market corporate debt denominated in USD or EUR offers a vast and diverse market with strong fundamentals, solid credit quality, and low default rates.
- By investing in these areas, investors can tap into the growth potential of emerging markets and partially mitigate potential further USD weakness, without taking on emerging market currency risk, as the emerging market segment typically benefits from a weaker USD.