Bonds remain a go-to investment for stability and income, but experts warn that investors must stay agile, factoring in economic surprises, inflation trends, and policy changes that could reshape the landscape in the year ahead, writes Piyasi Mitra.
The US economy remains the focal point for global fixed income markets, as its monetary and fiscal policies continue to influence yields, spreads, and risk appetite worldwide. With President Donald Trump’s administration continuing its pro-business agenda, including tax cuts and deregulation, economic growth remains steady.
However, the potential for trade tensions and inflationary pressures pose risks. According to Steven Bell, chief economist (Emea) at Columbia Threadneedle Investments, the UK economy, in particular, faces serious headwinds.
“After near 10% rises in the last two years, the minimum wage is going up by 6.7% in April. That will take the cumulative increase to 37% since 2021. For some younger workers, it is more like 50%,” he notes. With productivity gains lagging, Bell warns that such rapid wage growth could lead to higher inflation, weaker economic growth, and business failures, creating challenges for the Bank of England as it balances inflation control with economic support.
In the US, the focus remains on fiscal policies under the Trump administration, particularly trade and taxation strategies. Asset management firm Amundi’s outlook highlights that the Federal Reserve remains cautious, as it assesses the long-term inflationary impact of fiscal policies and keeps a close watch on yield volatility. “Beyond that, there are income opportunities to be explored from corporate credit in Europe, the US, and emerging markets,” Amundi’s report states.
Potential sovereign liquidity crunch
Diverging monetary policies among the world’s central banks are adding another layer of complexity to fixed income markets. Asset manager Carmignac warns that populist leaders elected on anti-inflation platforms will soon face harsh fiscal realities. “Sticky inflation and unsustainable fiscal paths will keep real borrowing costs elevated and foreign exchange markets extremely nervous,” the asset manager states.
As all major central banks shrink their balance sheets, a potential liquidity crunch could put pressure on sovereign bond markets, leading to heightened volatility. Investors, often referred to as “bond vigilantes,” may push back against governments with unsustainable fiscal paths by selling off bonds, causing a surge in borrowing costs. In Europe, the focus will be on France’s fiscal trajectory, as concerns grow over rising public debt and a potential financial crisis. Carmignac warns, saying: “If the French political class is unable to reverse the fiscal deterioration, the institutional crisis could morph into a financial crisis with global ramifications.”
Given the significant global exposure to French sovereign bonds, any instability in France could reverberate across markets. The European Central Bank will likely have to navigate this environment carefully, balancing its mandate for price stability with supporting economic growth in a region with diverging fiscal conditions.
Despite these challenges, fixed income still presents attractive opportunities in select areas. Amundi, for instance, outlines a tactical duration approach, favouring core European bonds while maintaining a positive stance on UK debt. In the US, Treasury Inflation-Protected Securities are expected to remain appealing for long-term investors, particularly in a scenario where inflation remains stubbornly above target.
Corporate credit markets also present opportunities. Investors are likely to favour investment-grade bonds with shorter maturities, as these provide a balance of yield and security. Emerging market bonds remain a mixed bag—while growth prospects are robust, dollar strength and potential tariffs on certain economies create additional risks. “We stay selective on local currency debt, favouring South Africa and parts of Latin America,” Amundi adds.
“If the French political class is unable to reverse the fiscal deterioration, the institutional crisis could morph into a financial crisis with global ramifications.”
Private credit: ‘rival’ to public fixed income?
One of the most significant trends reshaping fixed income markets is the rapid expansion of private credit. Assets under management soared from $500 billion before the financial crisis to $1.6 trillion today, and Preqin forecasts a rise to $2.8 trillion by 2028.
Michel Vernier, head of fixed income strategy at Barclays Private Bank, describes the relationship of private debt with public fixed income as both “competitive and complementary”.
Investor demand and stricter bank regulations have fuelled private credit’s rise, particularly as loan syndication hit a 12-year low, according to Pitchbook. Companies are increasingly turning to private lenders for flexibility and better access to capital. Institutional investors, especially insurance companies, are playing a major role in this shift, with Moody’s reporting that 80% of US insurers plan to increase private credit allocations.
Despite its growth, private credit is not replacing public fixed income. Vernier believes both markets will thrive as global wealth expands, with investors benefiting from their complementary roles in a diversified portfolio.
Investor interest in private credit is rising, driven by the democratisation of private markets overall. Vernier notes: “There is a confluence of factors likely to attract more capital to private credit.”
Funds that mix private and public debt, particularly European Long-Term Investment Funds (Eltif), are expanding access. “These funds allow investors to re-invest distributions and withdrawals without losing the benefits of closed-end structures,” says Vernier. Between March and September 2024, assets in 52 of these European funds grew by 26% to €52.8 billion, according to Novantigo. Despite growing adoption, nearly half of private banks do not yet include private debt in their strategic allocation.
As access expands, education and transparency will be crucial for investors navigating this evolving space. “The interplay between the dynamics is the key reason why public and private credit plays an essential role in the fixed income world. Private credit, for example, offers an additional liquidity premium; one of the factors why the segment has had higher yields and higher returns, compared to the loan markets, for example,” says Vernier. However, he highlights a trade-off: “Many private clients are buy-and-hold investors. By solely focusing on more liquid, public bonds, they miss out on these return benefits.”
Beyond yield, private credit opens access to a broader range of issuers, providing diversification and reducing overall portfolio risk. Given private debt returns are less prone to market moves, they also add more predictability to portfolio returns, he adds. However, liquidity remains key. “Liquidity, especially in this environment, is key to managing portfolios effectively,” Vernier cautions, reinforcing why public debt is also likely to remain a key “building block” within fixed income.
While increasing competition may tighten spreads in private credit, Vernier does not see this as the main driver of capital shifts. “The crucial exercise for investors is to find the right mix between private and fixed income markets to optimise their portfolio’s risk and return profile.”
