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Fixed income outlook: resilient US provides an anchor
David Hoag
Tim Ng
Damien McCann
Kirstie Spence
December 13, 2024
The enduring resilience of the US economy will be a key driver of financial markets in 2025 and beyond. Having avoided recession, the US is returning to mid-cycle, according to economic data, while inflation has continued to ease back towards the US Federal Reserve’s (Fed) 2% target, enabling the central bank to begin cutting rates. We believe the Fed views monetary policy as restrictive and will likely continue lowering rates, albeit at a slower pace than previously expected.
Strong economy could keep interest rates elevated
Sources: Capital Group, Bloomberg, Federal Reserve. Fed funds target rate reflects the upper bound of the Federal Open Markets Committee’s (FOMC) target range for overnight lending among U.S. banks. Median Fed projections are as of 18 September 2024. Latest data available as of 30 November 2024.
Against this backdrop, high starting yields, compelling relative value opportunities and a potential decline in interest rates provide a strong backdrop for fixed income, despite the generally tight level of spreads.
With a new administration taking charge in Washington in 2025, policies on tariffs and fiscal spending have yet to be fully articulated or implemented. As investors try to calibrate specific policies and their potential impact on inflation and the broader economy, we expect interest rate volatility to stay elevated in the near term. Nevertheless, some rate volatility is not a bad thing – it can create opportunities for active investors in duration, yield curve positioning and structured sectors such as mortgage-backed securities.
Meanwhile, bonds also appear to have returned to their traditional role as portfolio diversifiers. This was evident in early August 2024 when equity markets came under pressure on weaker-than-expected economic data. While equities sold off, bond markets rallied, mitigating losses for mixed asset portfolios. Over the past 50 years, negative correlation between bonds and equities typically occurred when inflation was close to the Fed’s 2% target.
Looking forward to 2025, inflation is trending, which means fixed income could once again provide a measure of income, diversification and ballast against stock market volatility.
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