Authors: Mike Riddell and Tim Foster, portfolio managers, Fidelity Strategic Bond Fund
Fidelity Strategic & Flexible Bond portfolio managers Mike Riddell and Tim Foster share their outlook for 2025 and provide an insight into how they are looking to position the portfolios against an evolving macro backdrop.
Looking across the global fixed income opportunity set, the picture is very mixed at the moment, with different markets pricing in very different outcomes for the global economy. On the one hand, some government bonds are still offering yields that have rarely been higher since the roaring 1990s, despite the fact that many central banks have already begun rate cutting cycles.
But on the other hand, the riskier areas of global fixed income markets offer far less enticing return prospects. A number of corporate bonds, especially those in the US, are offering among the tightest credit spreads over government bonds that have ever been seen.
What happens from here largely depends on global economic growth. If the global economy continues to chug along at or above historical trend growth rates, then riskier areas of fixed income could continue to hold up well for even longer. But any renewed signs of a global economic slowdown could see sovereign bonds deliver outsized positive returns, and corporate bonds underperform their sovereign counterparts, potentially by a substantial margin if a slowdown comes faster or deeper than expected.
But the worst outcome for most areas of fixed income is if we see another jump in inflation on the back of any global tariff or trade war. On that front it’s still too soon to tell. We will need more clarity on the details behind the measures, and expected timing of them, from the new US administration before we can form a clearer view of the inflation trajectory from here.
Positioning against this backdrop
As long-term value investors, we tend to be attracted to areas of the bond market that are historically cheap, and shun parts where valuations are trading at very expensive levels. With that in mind, there’s no question that sovereign bond yields are trading at historically cheap levels. The tougher question is whether these levels are justified in the short to medium-term.
At the global level, US imposed tariffs are likely to be stagflationary, where it’s probably more a case of ‘flation’ for the US and ‘stag’ for the rest of the world. We’re likely to get an acceleration in US fiscal stimulus too, although any stimulus could be offset by the axe that’s likely to be taken to the government sector. And even if the new US administration does deliver a fiscal boost, the US economy is already operating at close to full capacity. In that sense, additional stimulus would probably add little to GDP growth rates, but potentially a lot to inflation. A reacceleration of US inflation leaves us less optimistic for US Treasuries than sovereign bonds issued by other countries. But we think US inflation protection still looks fairly cheap.
Outside the US, government bond yields look too juicy to ignore given our expectation for a lower growth environment. Australian bonds, for example, could even benefit from aggressive US tariffs. China and the wider region in Asia would face a negative economic growth shock from punitive US policies, opening up the potential for a faster pace of rate cuts. Yet Australian sovereign bond yields have been blindly following US Treasuries higher, which now makes them a very interesting proposition. We have less conviction in currency markets at this juncture, but the Chinese renminbi could be particularly vulnerable to US trade policy and a strong US dollar.
Aside from government bonds and currencies, an area of fixed income that we think offers very slim prospects for strong returns is corporate credit. The all-in yields may look reasonable versus the last two decades, but this is entirely because ‘risk free’ sovereign bond yields are so elevated. The paltry extra spread on offer to investors for going down the credit risk spectrum is close to the lowest on record.
From a regional perspective, the US corporate bond market looks particularly unattractive. When credit spreads are as low as they are today, historical data shows that investors have barely ever achieved better returns buying US corporate bonds than similar maturity government bonds looking forward one, two or even three years. That’s because when credit spreads are so tight, they can’t tighten much more, but they can widen a lot if anything goes wrong. Spreads now seem priced for perfection, leaving the asymmetry of owning corporate bonds tilted very negatively for investors. Given this, we are not looking to own much credit risk for now until credit spreads widen to more attractive levels.
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Important information
This information is for investment professionals only and should not be relied upon by private investors. Investors should note that the views expressed may no longer be current and may have already been acted upon. Past performance is not a reliable indicator of future returns. The value of investments and the income from them can go down as well as up and clients may get back less than they invest. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than in other more developed markets. The price of bonds is influenced by movements in interest rates, changes in the credit rating of bond issuers, and other factors such as inflation and market dynamics. In general, as interest rates rise the price of a bond will fall. The risk of default is based on the issuer’s ability to make interest payments and to repay the loan at maturity. Default risk may, therefore, vary between different government issuers as well as between different corporate issuers. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of investments. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document, current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Fidelity only gives information on products and services and does not give investment advice to retail clients based on individual circumstances. Any comments or statements made are not necessarily those of Fidelity. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. FIPM 8662
