Fixed income is caught in a tug-of-war right now says Richard Carter, head of fixed interest research at Quilter Cheviot.
Sharing his insights, Richard unravels some of the complexities of current market conditions and uncertainties, highlighting their potential impacts on fixed income investment selection within multi-asset strategies. He also tells us why he believes it’s time to be active when it comes to fixed income allocations.
On one side of that tug-of-war, the turmoil in the Middle East has shown how quickly an “unknown unknown” can become a real risk. In theory, bonds should be the steady hand in times like these. But markets have reacted to this conflict mostly as an inflation shock, not a growth shock, and that distinction matters.
On the other side, yields are up and hard to ignore. With 10-year gilts near 5% at the time of writing in mid-April, and investment grade credit offering extra spread, fixed income is back as a genuine source of returns, especially if the conflict cools and energy prices drop. Still, bonds remain vulnerable while inflation dominates the headlines.
That’s why fixed income positioning in multi-asset portfolios is so important today. Investors remember 2022, when bonds failed to diversify as expected. The real question now is how do you build a fixed income allocation that can handle wild swings in inflation expectations, sudden shifts in central bank policy, and assets that don’t always behave defensively?
What’s stopping diversification?
In a classic growth slowdown, high quality government bonds have tended to provide ballast. The problem is that markets are not currently behaving as though we are dealing with a neat, textbook slowdown. Much of the recent anxiety has been interpreted first and foremost as inflationary, driven by energy risk and the knock-on effects that can ripple into prices more broadly. In that environment, bonds can struggle because inflation uncertainty pushes yields up and prices down, at least until growth weakness becomes the dominant story.
That also goes some way to explaining why equity-bond correlations have been higher than many investors would like. When inflation is the fear, both equities and bonds can sell off together, and when de-escalation hopes rise, both can rally. The point is not that bonds do not diversify anymore, it is that they diversify a specific type of shock.
For portfolio managers, this is where portfolio design becomes real rather than theoretical. A portfolio built to withstand a growth slump will not look identical to one built to withstand an inflation flare-up. Fixed income allocations must balance those risks.
The more constructive part of the story is that yields have risen and now look attractive on a longer-term basis. 10-year gilt yields are close to 5%, levels not seen since 2008. This is crucial as this will allow investors to be paid to hold a defensive asset during choppier times. Furthermore, even if that path is volatile, those higher starting yields begin to offer some natural cushioning.
But it would be a mistake to think this is ‘back to normal’. Higher yields also mean duration risk is once again live. When central bank expectations swing, long-dated bonds can move sharply, and those moves can dominate returns over short periods.
That is why the outlook for central banks is crucial. The market has repriced quickly, with expectations shifting materially over a short period – although some of this may be slightly exaggerated by a nervous market. However, whether the market is too hawkish or too dovish at any given moment, the bigger takeaway is that the range of plausible outcomes has widened. Unintended risk can quickly creep into portfolios if duration is seen as a fixed setting.
But, for lower-risk investors, some of the most appealing opportunities are in short-dated bonds. With two-year gilts around 4.3% and sub-five-year investment grade credit offering around 5%, these sit comfortably above current inflation and above some current assumptions for where inflation may head if the conflict drags on.
Shorter maturity exposure can be helpful in multi-asset solutions for two practical reasons. It typically carries less sensitivity to sharp yield moves than long duration, and it gives you optionality by reinvesting at future yields rather than locking in a long duration position at the wrong moment.
That is not to say long-dated government bonds have no place. If a long-lasting conflict does begin to hit growth meaningfully, government bonds may stand to benefit to a degree. The nuance, again, is that any rally could be constrained if inflation risks remain elevated, and it certainly seems that will be the case regardless of what ceasefire can hold.
Beyond sovereigns
Corporate bonds bring their own risks too though. Spreads are already tight, and there’s real downside if growth shocks follow this inflation shock. The Middle East isn’t the only worry with private credit “blow ups” making investors nervous too.
That’s why we’re cautious on credit and prefer investment grade over high yield. Investment grade offers a stronger blend of yield and resilience. High yield is less forgiving if the focus shifts to real economic damage, where spreads could widen and investors risk chasing yield in parts of the market that act like equities when things get tough.
Furthermore, knowing your fixed income’s geographic exposure will be important. UK yields look tempting, but government debt is high and the political backdrop is shaky. Meanwhile, US debt levels are even higher, and Europe faces spending pressures. The options are tough and as such proper research is needed.
With interest rate cuts on ice, and maybe even hikes ahead, diversification can feel hard to achieve. But this is the time to be active with your fixed income allocations. The asset class hasn’t behaved as many hoped, but it’s still useful when handled well. Lower-risk assets can’t just be “set and forget”. To truly diversify and manage risk, you need an adaptable strategy, especially with more surprises surely on the horizon.
This feature was part of our 2026 Fixed Income Insights. For deeper analysis on bond markets and rates strategy for advisers, explore IFA Magazine’s latest Fixed Income Insights publication.
About Richard Carter
Richard is Head of Fixed Income research at Quilter Cheviot. His primary role is to provide attractive fixed income investment recommendations that will ultimately benefit Quilter Cheviot clients. His main area of expertise is the global bond market, which includes government, corporate and emerging market and he chairs the firm’s Fixed Interest Committee and is also a member of the Asset Allocation and Collectives committees. Richard has worked at Quilter Cheviot for over 6 years and has a total of 16 years of investment experience. In his previous roles, he was a fixed income analyst and fund manager at Barings and BNY Mellon.
