A Quick recap

In early 2024, concerns arose that headline inflation was proving to be stickier than expected. Nonetheless, central bank rate cuts finally materialised in the second half of the year, as anticipated.

In the last two months, Donald Trump's election victory pushed medium and long-dated Treasury yields significantly higher due to fears that his economic policies would be inflationary. Geopolitical tensions also added to the upward pressure on the yield curve.

Global economic growth was more resilient than forecast, with strong corporate profitability supporting credit spreads, which tightened significantly over 2024.

These developments had a mixed impact on fixed-income returns, with pure government bond strategies lagging the positive performance from corporate and emerging market strategies.

The higher all-in yields now available have heightened the attractiveness of fixed income. Several additional themes should further bolster the case for fixed-income investments.

Key themes for 2025

We expect monetary policy to diverge in developed markets. The US Federal Reserve has already pared back its rate-cutting cycle as it waits to see the impact of Trump's policies. Market consensus ranges from zero cuts to two in the latter stages of the year. By contrast, the European Central Bank, arguably behind the curve, looks set to cut deeper and quicker than previously forecast in the face of mounting economic headwinds. Stubborn UK inflation had given the Bank of England reason to pause. However, January’s numbers were weaker than expected, opening the way for potential reductions.

Yields and spreads

Global IG bonds’ all-in yields across developed and emerging markets are attractive. The yield to maturity on the Barclays Global Average Corporate Index is currently 4.8% compared to the historical average of 3.1% (going back to December 2004).  When comparing the past 10 years, the current yields available for all the main fixed income sub-asset classes are also well above the long-term average (see Chart 1). This should appeal to those coupon-clippers looking for an attractive income.

Higher yields also often lead to tighter spreads outside a recession. That said, the prospects for further spread compression could be more limited now that they are below long-term averages. Still, there could be some scope for spreads to grind lower, particularly on a selective basis.

Economic sweet spot

Turning to GDP, history shows that modest economic growth is typically better than high growth for IG credit. Starting in 1948, periods of 1-2% growth resulted in excess returns for IG. High growth (above 3%) was relatively poorer for IG. That’s because, during phases of robust growth, focus tends to shift towards shareholder value at the expense of bondholder value. As it stands, we think 2025 will deliver modest economic growth, suggesting a good environment for IG credit.

A comparative advantage

Fixed income stands out compared to other asset classes on a risk and relative valuation basis. With strong fundamentals, higher yields, lower volatility, and a position higher up the capital structure, fixed income presents a lower-risk and potentially higher-return investment option to regular stocks. At the same time, five-year US Corporate yields are above the S&P 500 earnings yield (5.2% versus 3.4% [1]), indicating attractive relative valuations.

Moving beyond cash

There’s also a compelling case for investors to transition from cash and money market funds into fixed income. With the ability to capture over 100 basis points in excess yield, fixed income offers a tangible opportunity for investors to enhance their returns while effectively managing risk. The potential upside could be significant. By our estimates, there’s around US$7 trillion sitting on the sidelines, poised to enter the market.

Final thoughts…

The ‘reasons to believe’ in fixed income are clear. Yields are historically attractive, and fundamentals are strong. In a complex and unpredictable world, the asset class has a safety and valuation advantage over riskier assets like equities.

We believe embracing the fixed income opportunity could unlock significant value for portfolios, marking a timely strategic move in a world of turbulent economic, political, and market dynamics.