CONTRIBUTORS
Michael Buchanan, CFA
Chief Investment Officer
Western Asset
Key takeaways:
- We are optimistic about fixed-income returns in 2025 given the prevalence of higher available yields.
- While global growth is downshifting, we expect it to remain positive. US growth should continue to outpace most other developed markets.
- Inflation globally is now very close to central bank targets, although there are intercountry discrepancies, such as stubborn inflation in the US (an outlier among DM economies). The overall trend gives central banks room to cut policy rates.
- Spread sector fundamentals should remain supportive, and current valuations reflect this.
- We see opportunities to hold duration in select developed markets such as Australia, the UK and in core Europe, as well as in short-dated USTs.
- Select parts of the securitized and corporate bond markets offer attractive return potential.
Overview
Global growth has slowed, and inflation rates have declined markedly across both developed market (DM) and emerging market (EM) economies. Our base case calls for these trends to persist. Goods price inflation is running modestly below pre-pandemic levels and, with ongoing deflationary pressures from Asia, it’s hard to envision a meaningful persistent uptick. Services inflation should continue to slow as wage pressures abate with the softening jobs market and slower demand in the service sector. The inflation backdrop has generally allowed key DM central banks to begin reducing policy rates at a time when the growth backdrop is calling for less restrictive policy; however, the US remains an outlier among DM economies with its stubbornly higher inflation. The global growth trajectory, however, is highly dependent on US government policy outcomes. We remain overweight to interest-rate duration, particularly given the recent rise in yields. We see value in Australia, the UK and in core Europe, as well as in short-dated US Treasuries (USTs) that are less susceptible to the uncertain outlook for US fiscal policy. Spread sectors have performed well, and we expect this to continue. However, valuations are trading at or through historical averages. We see value in select sectors and names. EM debt appears to remain fundamentally attractive, but both internal and external political risks have hampered performance in some countries.
Conclusion
We anticipate a strong year for fixed-income markets, driven by attractive yields and opportunities in select spread sectors. We see value in certain DM government bonds, including those in Australia, the UK and broader Europe. We also see opportunities in certain credit investments, including structured credit, especially commercial real estate and CLO tranches, as well as higher-rated bank loans. Potential volatility, particularly with the new US administration, highlights the importance of active management.
Download the report to read about the Western Asset team’s views on key drivers and relative value by region, and sector and industry themes.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
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. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
Municipal income may be subject to state and local taxes. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.
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.
US Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the US government. The US government guarantees the principal and interest payments on US Treasuries when the securities are held to maturity. Unlike US Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the US government. Even when the US government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.