2025 Global Fixed Income Outlook
First Quarter
Key Takeaways
While it’s been slow to surface, we think a U.S. economic slowdown remains likely due to still-high interest rates and inflation.
At the same time, uneven economic data, the Fed’s easing strategy and Trump administration policy priorities may lead to continued market volatility.
Rates Volatility Likely to Linger as Fed, Fiscal Policies Unfold
Recent dynamics in the U.S. Treasury market highlight lingering economic and political uncertainties facing investors. We believe these influences will likely generate continued interest rate volatility into early 2025.
Between September 18, when the Federal Reserve (Fed) launched its latest easing campaign, and November 20, U.S. Treasury yields defied conventional wisdom. Instead of tracking the federal funds rate lower, the 10-year Treasury yield jumped 80 basis points (bps). It’s important to note that in this two-month span, the Fed cut rates a total of 75 bps.
Economic Slowdown Predictions Hold Steady for 2025
Better-than-expected economic data, renewed expectations for stronger U.S. growth, and higher inflation under the Trump administration largely contributed to the late-year Treasury yield surge. However, in our view, such expectations don’t reflect the full story.
Still-high interest rates, persistent above-target inflation and weaker labor market data may eventually weigh on the economy. We still believe the U.S. is likely headed for a slowdown in which flat to slightly positive economic growth will emerge. We have a similar view outside the U.S., where growth has remained weaker and inflation has persevered.
Accordingly, we expect uneven economic data combined with policy reveals to lead to continued bond market volatility. But, as history has frequently demonstrated, volatility often leads to opportunities.
Policy Uncertainties Complicate Fixed Income’s 2025 Outlook
The Treasury yield surge subsided somewhat in the weeks following the U.S. election. Fears of a significantly higher federal deficit gave way to a more tempered outlook as markets digested the results. Meanwhile, recent comments from Fed Board Chair Jerome Powell disrupted earlier outlooks for several Fed rate cuts through 2025.
This uncertainty will likely trigger the volatility we anticipate over the next few months:
Trump mandates. We believe President-elect Donald Trump has a clear mandate to tackle immigration, crime and cost-of-living issues he highlighted during the campaign. However, given the thin Republican majorities in Congress, we’re skeptical that his mandate extends to large tax cuts and massive deficit spending. In theory, Republicans favor fiscal conservatism and smaller government, suggesting that some GOP members of Congress may object to any fiscal largesse.
Tariffs. Trump appears likely to impose tariffs on select goods from China, but his broader tariff strategy remains unclear. Furthermore, the impact on inflation may not be as dire as the market expects, given that some tariffs could restrict demand and slow down consumption.
Fed easing. After outlining a framework in September that cut interest rates well into 2025, Powell noted in November that the Fed is in no hurry to ease. With growth relatively healthy and inflation still above target, he said that rapid rate cuts weren’t necessarily in the cards. These comments, combined with uncertainties regarding Trump policy priorities, suggest the Fed will pursue a cautious, wait-and-see approach that affords the Fed flexibility.
Finding Opportunities in a Volatile Bond Market
The bond market enters 2025 questioning the various outcomes from fiscal and monetary policy and tariffs. Therefore, we expect bond yield volatility to dominate.
In this environment, we remain selective and generally favor higher-quality bonds. As uncertainties continue, we also believe maintaining a shorter duration strategy is prudent.
U.S. Government
We expect the 10-year Treasury yield to remain rangebound as the market digests upcoming economic metrics and the Fed’s agenda. We also expect the yield curve to continue normalizing, prompting us to emphasize the curve’s short and intermediate areas. We believe this strategy offers attractive near-term potential from a Fed policy perspective while potentially guarding against the longer-term effects of the massive federal deficit. With some inflation data rising recently, we also are monitoring breakeven rates and may add Treasury inflation-protected securities (TIPS) exposure if valuations improve.
U.S. Securitized
We still favor the agency mortgage-backed securities (MBS) sector, particularly as the yield curve steepens. Additionally, we believe this sector offers relative value versus others due to its high quality and relative protection from broader market volatility. Among credit-sensitive subsectors, we prefer higher-quality, shorter-duration securities, including asset-backed securities (ABS), which we believe offer attractive value versus short-duration corporates, and collateralized loan obligations (CLOs) with low call risk. Overall, we favor subsectors with strong technical backdrops, solid fundamentals and structural protections.
Municipal
We believe the relatively high quality and longer duration of municipal bonds should aid the asset class as the economy slows. Municipal credit fundamentals appear durable, supported by reserve fund balances and conservative budgeting. We expect state revenues to level off, with absolute revenues remaining elevated versus pre-pandemic levels. With the election behind us, we will assess and monitor potential federal tax policy and the implications for municipal bond demand. In the meantime, we still favor higher-quality issuers and sectors and believe security selection remains crucial to performance, particularly among high-yield issuers.
U.S. Corporate & Non-U.S. Developed Markets
We favor higher-quality, higher-yielding, shorter-duration securities in the U.S. and non-U.S. investment-grade and high-yield markets. We are focusing on high-conviction bonds with attractive valuations. We expect to reduce overweight positions in utilities and other investment-grade cyclical sectors approaching our spread targets. Solid fundamentals and valuations in the banking sector support our overweight positions in the U.S. and Europe. Bottom-up security selection continues to drive our exposure among high-yield corporates in the U.S. and Europe, where our focus remains on BB- and B-rated securities. We’re also finding opportunities in the new-issues market.
Money Markets
Given that the market expects only one Fed rate cut in the first quarter of 2025, we prefer a balanced fixed- and floating-rate coupon securities strategy. We expect to use methodical break-even calculations and a laddered maturity profile. This represents the opposite of our fourth-quarter strategy, which included large, outsized positions into predictable Fed moves. (Currently, 2025 is much less predictable.) Additionally, upon catalyst-driven events, we will carefully select opportunities to purchase and sell when volatility spikes, which we anticipate will happen again. We expect the debt-ceiling debate to surface late in the first quarter, and we will begin our strategy of investing around that June event.
Emerging Markets
We remain cautiously optimistic about emerging markets (EM) sovereign spreads amid post-election demand for U.S. dollar-denominated assets. Expected fiscal support in China, which should boost commodity prices and EM growth, further supports this optimism. At the same time, stretched valuations, increasing geopolitical risks and the U.S. fiscal backdrop keep us somewhat cautious. Countries and corporates in the BBB/BB-rating space with attractive valuations and solid credit fundamentals represent our highest convictions. On the local side, we’re maintaining a neutral rates position. Local fundamentals remain supportive, but the threats of higher fiscal spending in the U.S. and fewer Fed rate cuts warrant caution. We have turned negative on EM currencies in the medium term and expect to buy the U.S. dollar on near-term dips. This may occur toward year-end amid negative seasonal influences for the dollar and repricing in the federal funds futures market. Over the medium term, tariff risks, deregulation and further fiscal stimulus should aid the U.S. dollar versus the rest of the world.
The letter ratings indicate the credit worthiness of the underlying bonds in the portfolio and generally range from AAA (highest) to D (lowest).
References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.
Diversification does not assure a profit nor does it protect against loss of principal.
Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
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