Market Insights at a Glance
President Trump’s trade and foreign policy changes have created uncertainty and volatility in financial markets, leading to a divergence in fixed-income returns—with strong performance from US and many emerging market government bonds, and negative returns from Japanese and core eurozone government bonds. Despite this volatility, our outlook for fixed-income markets remains optimistic due to high overall yields, downshifting yet strong global growth and central banks’ capacity to cut rates if needed.
This summary is intended to aggregate the Firm’s current overall views and present an at-a-glance dashboard.*
Growth
Convictions
- Global growth is downshifting but remains in positive territory.
- The US economy is expected to slow to a below-trend growth rate influenced by cautious consumer spending and business hiring in 2025.
- The eurozone is projected to pick up due to resilient consumer activity and fiscal measures like increased defense and infrastructure spending.
Rationale
Inflation
Convictions
- Global inflation is generally moving toward central bank targets with significant progress since the pandemic distortions.
- US inflation is more stubborn and likely to tick higher in the near term before resuming a downward trajectory toward the Federal Reserve’s (Fed) 2% target.
- Tariffs are expected to have a one-off effect on price levels rather than causing ongoing inflation. The bond market is largely pricing in these tariffs.
Rationale
Rates
Convictions
- US Treasury (UST) yields have moderated from their January highs and the yield curve has steepened.
- The spread between UST 10-year yields and German government bond yields compressed significantly from about 220 basis points (bps) to about 140 bps, indicating a dramatic underperformance of German bonds.
- Japanese government bond (JGB) yields are expected to move higher in the long run.
Rationale
Monetary Policy
Convictions
- Central banks have room to cut rates in response to economic conditions and in support of the fixed-income market.
- The Fed is expected to continue cutting rates despite a near-term uptick in inflation, as the policy rate is currently viewed as restrictive.
- The European Central Bank (ECB) is anticipated to ease policy further with two expected rate cuts this year, while the Bank of England (BoE) is also projected to cut rates more than the market currently expects.
Rationale
Credit Markets
Convictions
- Investment-grade credit fundamentals are strong, but spreads remain tight and require tactical opportunities to add exposure during periods of volatility.
- High-quality high-yield credits, particularly those considered “rising stars,” offer good total return opportunities. Finding attractive valuations requires scrutiny and patience.
- Commercial mortgage-backed securities (CMBS) present compelling relative value due to improving fundamentals, low leverage and elevated spreads compared to other sectors.
Rationale
Geopolitics
Convictions
- Trump administration tariff policies are creating significant uncertainty, impacting global trade and economic growth.
- The EU’s new defense spending and infrastructure plans are expected to boost confidence and economic activity, though their impacts will be gradual.
- While the recent Ukraine ceasefire deal has potential to reduce energy costs and boost market confidence, long-term stability remains uncertain.
Rationale
*As of 31 Mar 25
Fixed-Income Outlook: Navigating Renewed Volatility and Policy Uncertainty
Markets have seen extremes since the start of 2Q25 as they attempt to digest the latest political maneuvers. Tariff negotiations between the US and other key trading partners resulted in confusing headlines that often conflicted with what had been reported just days prior. It is unlikely that we will have a near-term resolution to the overall US tariff policy, but we remain hopeful that negotiations are progressing in the right direction for markets. However, as discussed in our 2Q25 Market & Strategy Update webcast, we continue to anticipate that elevated volatility in fixed-income markets will persist over the short term both in terms of spreads as well as overall rate volatility. This may also present investment opportunities.
Building off our views as expressed during the 2Q webcast, we continue to refine our outlook across several key areas:
Macro and Economic Update
US Economy: Soft Landing Remains On Track
Growth is moderating, not collapsing. However, the reintroduction of tariffs could dampen consumer sentiment and corporate margins, potentially slowing investment. Despite prevailing market uncertainties, the US economy is expected to maintain modest positive growth throughout 2025. Core inflation metrics are already demonstrating a welcome moderation in services inflation, while any inflationary pressure from tariffs is expected to be temporary, affecting only a single year. In the absence of a recession, we anticipate UST yields will fluctuate within a contained range of 4% to 5%. We believe that the US will outpace most developed markets in 2025 but downside risks have increased.
US Inflation: Steady Declines Hold Promise
Tariffs may impact various areas of the economy, especially in the goods categories. We continue to expect core inflation trends will moderate over time, albeit slower than previously forecast.
Central Banks and Rates
Fed policy is likely to keep rates higher for longer relative to earlier expectations. While the Fed remains positioned to cut if needed, tariff-driven inflation noise may delay action. As the Fed pursues its dual mandate of maintaining stable prices while maximizing employment, it may face difficulty regarding rate cut timing, especially as Trump has taken an adversarial stance against Fed Chair Powell. This puts Powell in a potentially difficult position: he must not appear as if he’s capitulating to Trump’s demands, but rather focusing solely on the data given the Fed’s long-standing proclamations of data dependency.
The ECB is expected to implement additional rate cuts this year as headline inflation approaches target levels and services inflation begins to moderate as anticipated. Economic prospects should improve from Germany’s infrastructure fund and increased EU defense spending, supporting our strategic decision to maintain a modest overweight duration position across both nominal and inflation-linked securities.
Growth across Europe and the EU has remained constrained since mid-2024 and will likely stay subdued, while headline consumer price inflation in the region, though elevated, is expected to return to the BoE’s 2% target over its forecast horizon. We anticipate further labor market softening will dampen wage growth, giving the BoE confidence to implement more rate cuts than markets currently expect, which should enable UK gilts to deliver positive returns. In Asia, we expect the Bank of Japan to continue tightening policy, but at a gradual and measured pace.
Tariffs and Turbulence: A Closer Look at Market Volatility and Fixed-Income Implications
The new US administration’s proposed tariffs and policy changes have introduced significant uncertainty and volatility into financial markets. Despite this unpredictability, global growth is anticipated to slow but remain in positive territory. US growth is decelerating due to various factors, including tariff uncertainties, diminishing immigration benefits and reduced government spending. In contrast, the eurozone is expected to see a boost in confidence and growth from substantial fiscal initiatives in European defense and German infrastructure, which should help mitigate some tariff-related uncertainties.
China continues to face deflationary pressures and weak confidence due to property market issues, though sentiment is gradually improving with fiscal stimulus and policy easing. In the US, the disinflationary trend may be temporarily disrupted by tariffs and retaliatory measures, as mentioned earlier, but we anticipate inflation will resume its downward trajectory over the longer term.
Monetary policy remains restrictive, and generally we expect central banks to continue cutting rates in 2025. The Fed is well positioned to provide support if the US economy weakens. Public debt levels are rising, and yield curves may steepen further due to global fiscal policy concerns. While we maintain a modest overweight in interest-rate duration, we are focused on shorter maturities that are more responsive to policy changes in a slowing global economy.
Sector spreads have widened, making valuations attractive in our base-case scenario. We have started to incrementally add to positions, particularly in investment-grade and high-yield corporate securities.
Opportunities in Fixed-Income: 2025—Quality Matters
Higher-Quality High-Yield: Looking at rising-star candidates, we stress durability in rough economic conditions but we see the potential for attractive upside in our base case.
- We are focusing on the BB rated segment of high-yield issuers with strong asset coverage, stable free cash flow generation and the ability to navigate through a growth slowdown given limited near-term debt maturities and margin resiliency.
- Current valuations for these high-quality, high-yield opportunities provide attractive income generation potential with yields and spreads that are materially higher/wider than was seen just a few months ago. These opportunities offer incremental total return potential as spreads tighten from the recent widening we’ve experienced given the stable underlying fundamentals of these specific credits.
AAA CLO: Spreads have cheapened for this asset class, fitting the high-quality income theme.
- We mostly favor floating-rate (no rate duration) collateralized loan obligations (CLOs), which are scalable via both the primary and secondary markets. The CLO market is approximately $1.4 trillion, of which about $1 trillion is rated AAA.
- This market benefits from broad adoption by institutional investors both domestic and foreign. AAA CLO ETFs have grown meaningfully in the last couple of years as retail investors have now fully embraced the strong historical track record of CLOs. Per Bank of America research, CLO ETFs have the highest Sharpe ratio within the fixed-income ETF universe. We expect continued ETF inflows from retail channels along with continued institutional support from asset managers, insurance companies (which have approximately $300 billion in CLO investments) while recent NAIC rule changes will likely lead to increased US bank demand for CLOs, as banks currently hold around $200 billion in CLO investments. We also expect foreign demand (e.g., from Japanese banks, which currently hold about $100 billion in CLOs) to remain steady as AAA CLOs continue to offer an attractive yield pickup versus JPY-denominated investment-grade corporates.
- Currently, AAA spreads have widened to a discount margin (dm) of around 160 bps, with a current yield of approximately 5.85%, which screens very well compared to other comparably rated fixed-income investments. Given the recent widening, secondary-market AAA investments can be sourced in the 98-99 bps range, offering positive price convexity. Within AAA CLOs, given a flat term structure, we favor mid-tenor AAAs in the 160 dm ~99-99.5 bps context along with select, recently issued, longer-tenor AAAs with strong structures and high credit enhancement in the 98 handle $ price area.
CMBS: Improving fundamentals including strong new market issuance.
- Commercial real estate (CRE) debt spreads remain wide, while underwriting standards are constrained, generating a low-leverage, high-quality opportunity set with both current income and total return potential.
- Property prices likely have bottomed out, and growth is positive and accelerating off of cyclical lows. Fundamentals are generally healthy (excluding obsolete office space) and new supply pipelines are limited as construction starts have been curtailed.
- We are mindful of tariff and policy impacts as a growth recession or stagflation environment could lead to demand destruction and declining revenue across CRE sectors.
