CONTRIBUTORS
Sonal Desai, Ph.D.
Chief Investment Officer,
Portfolio Manager
Nikhil Mohan
Economist
Franklin Templeton Fixed Income
Angelo Formiggini
Economist,
International Research Analyst
Mike Salm
Director of Multi-Sector Strategy
Patrick Klein, Ph.D.
Director of Multi-Sector Strategy,
Portfolio Manager
United States
Albert Chan, CFA
Head of Portfolio Construction & Analytics
Executive summary
We remain upbeat on the US economy, with consumer spending driving moderate economic growth and reining in the number of cuts that the US Federal Reserve (Fed) will need to orchestrate a soft landing. There remains the potential for policy surprises as President-elect Trump moves forward with large, proposed mandates such as increased tariffs and immigration changes that may cause additional inflation pressures. In Europe, growth is still a concern for the European Central Bank as policy rate cuts are projected to outpace the United States.
Some fixed income sector spreads remain at multi-decade lows, but we are still finding value within securitized sectors that offer some diversification benefits to portfolios.
In this quarter’s Sector Views, we look closely at the following themes and provide our outlooks for fixed income sectors:
Portfolio themes
- Fed expectations, what a quarter can do: Fed Chair Jerome Powell signaled at the central bank’s December policy meeting that further rate cuts will likely be slower and more targeted. His outlook on inflation is now higher due both to policy uncertainty and to the recent sticky inflation readings.
- Trump 2.0: Fixed income—who wins? As we move toward the January swearing in of Donald Trump, we need to look at the implications of proposed policies on fixed income sectors. The continuation of US “economic exceptionalism” is expected as many of Trump’s policies will be focused on protectionism, such as higher tariffs on imported goods and limits on immigration.
- Look for other baskets: US corporate bond spreads have reached 20-year lows and keep on tightening. The investment-grade corporate bond sector makes up about 25% of the Bloomberg US Aggregate Index. This exposes the index to significant downside risk in a spread-widening scenario.
Overall risk outlook
We have upgraded our overall risk setting to neutral, primarily due to an improving US economic picture which has supported market fundamental and technical conditions. Against this background, positive interest rate carry is still a focus in our investment decisions. By selecting fixed income positions that can provide monthly income pick-ups, it should allow us to add to returns independently of moving yields and the shape of the yield curve. Within the fixed income universe, we feel some sectors are less vulnerable to negative policy surprises. Lower-quality corporate bonds are more dependent on the robustness of the US economy and less exposed to potential policy changes (albeit spreads are extremely tight already). Proposed reduced bank regulation should be a tailwind for securitized products. On the other side, major shifts in US policies should strongly impact non-US corporate credit and emerging market bonds, and here investment focus should be on selecting those sectors and issuers that have some degree of insulation from US policy swings.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
Asset-backed, mortgage-backed or mortgage-related securities are subject to prepayment and extension risks.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Leverage increases the volatility of investment returns and subjects investments to magnified losses and a decline in value.