The one constant we expected from the new US administration was volatility, driven by uncertainties over trade, fiscal, and immigration policies. But we have still been surprised by the level of volatility across global markets in the first 100 days.
Fixed income markets have shared concerns with their equity counterparts over the potential end of US exceptionalism. US government and corporate debt have underperformed other developed markets significantly in the year to date.
Additionally, there has been a sharper increase in longer-dated US government bond yields, reflecting an increasing term premium for the higher inflation that increased tariff rates may produce in the US.
There are also concerns over central bank independence, and longer-term doubts have been raised over foreigners’ willingness to continue funding large fiscal deficits in the US.
As a result of the high tariff rates, economic consensus believes the chance of a US recession in 2025 is equivalent to a coin toss. But the retreat of the Trump administration from its maximalist tariff position, partly due to pressure from the sharp declines in US equity and government bond prices, means that economic policy uncertainty persists and has only ever been higher in the last 40 years during Covid-19 and the global financial crisis.
We therefore do not attempt to predict what turn US policy may take next, but prepare for a wide range of outcomes by looking for signposts that guide us down the myriad potential paths.
Despite all the volatility, our key marker points have not changed since the beginning of the year: the health of US employment; the size of fiscal largesse globally; and the strength of investor demand for fixed income.
The US jobs market, which directly impacts the health of the US consumer, has entered this period in a strong state. The abrupt halt in US immigration also provides some counterbalance to the weakness that may arise as business confidence has been hit.
Our central investment thesis since the pandemic has been that a seismic shift from monetary policy to fiscal policy has taken place across the globe. Governments that are currently sitting on large deficits will need to focus on growth – austerity is not an option.
Germany has already capitulated on its previous fiscal hairshirt. And in the US, this is truer now than ever, as the administration will look to even higher fiscal spending to offset some of the economic hit from the tariff proposals.
This should result in better growth, as well as higher inflationary outcomes, which means we remain cautious on having higher duration until recessionary impulses become clearer.
Investor demand for fixed income has been strong over the past few years as yields have become attractive, following the rate hiking cycle across developed markets. There have been outflows during the recent period, though they have reduced as the markets have bounced back.
Some of the outflows have been concentrated in shorter maturity assets, which presents some interesting opportunities ahead to pick up good risk-adjusted returns for nimble investors.
We have also seen sustained demand for longer-duration US investment-grade credit from both domestic pension funds and international buyers. Asian demand for higher-yielding assets has also remained robust.
Therefore, we still see appeal in some higher-yielding asset classes that are less exposed to tariffs, such as bank subordinated debt. We expect demand to remain intact for fixed income, albeit less strong than it has been. But we are aware that a rapid rate-cutting cycle, if the recessionary path becomes clearer, would eventually lead to lower yields and then less demand for fixed income.
As the investment ‘looking glass’ for 2025 is unusually murky, we believe it is now more important than ever to maintain a wide range of investments across fixed income asset classes and to adapt quickly as market dynamics change.
Compared with traditional bond funds, strategic bond funds can invest across a broader range of fixed income assets and duration. This can provide the flexibility and diversification required to capture potential opportunities and mitigate risks in a more efficient and effective manner.
Matthew Rees is head of global bond strategies, asset management at Legal & General. The views expressed above should not be taken as investment advice.