Bond market strength in 2024 still presents active investment opportunities according to Gregory Peters, Co-Chief Investment Officer PGIM Fixed Income, as he points to easing rates and diverging policies creating entry points across the yield curve.
Bullish bond conditions born out of the 2022 bear market persisted in 2024. Major central banks eased short-term rates during the year and further rate cuts may materialise in 2025. Global rate correlations should decrease as growth and inflation dynamics continue to widen, which should prompt uneven central bank policy responses. Against this diverging backdrop, we maintain a positive fixed income outlook and think current conditions offer a compelling entry point for investors, especially those on the sidelines or overallocated to equities after the stock market’s recent run.
A more gradual path to neutral
Global economy: The global economy is resilient. Moderation remains our base case, with the potential for a recession in 2025 declining. In the U.S., we expect GDP growth of ~1.8% in 2025. We see modest growth in the euro area in 2025 as economic conditions improve. We believe China’s growth may be close to 4.5% given recent stimulus measures.
Interest rates: Interest rates have passed their peaks, potentially adding momentum to the existing bull market. Quarterly fluctuations notwithstanding, odds favor stable-to-lower yields ahead, which bodes well for fixed income returns whether they come from carry or total return.
Short-term rates: Prospects for inflation to linger in the U.S. forced markets to recalibrate aggressive rate expectations from the onset of 2024 to a more measured pace of cuts in 2025.
Although uncertainty abounds, the fed funds rate could drop below 4% by the end of 2025, while we anticipate an ECB deposit rate of 2.25% by mid-2025.
Long-term rates: While we expect range-bound rates, we see a wide range of 3.5% to 4.5% for the 10-year U.S. Treasury. Rising potential for inflation to remain elevated along with massive deficits will likely continue to fuel the unending wave in Treasury supply, providing investors with additional opportunities to lock in elevated long-term yields.
Foresight and flexibility required
From secular stagnation to generational highs in inflation, paradigm shifts and entire market cycles are playing out in market swings normally observed across a matter of quarters.
Navigating an ever-changing market underscores the importance of agility and anticipation, particularly when signs of another paradigm shift emerge. With dispersions high across many sectors and regions, credit selection remains critical to outperformance.
Solid credit fundamentals
Although credit spreads are tight and vulnerable to short-term setbacks, fundamentals remain firm, as does net demand for fixed income as growth moderates. Default expectations generally remain below historical averages. This combination of factors suggests that spreads may remain in a historically tight range for some time to come.
In terms of potential surprises, an unexpected acceleration in inflation, particularly based on the various core measures, could catch participants leaning the wrong way, making active management critical.
Opportunities across the yield curve
Redeploy cash: As cash rates fall, investors may be spurred to extend out on the curve and into spread products to lock in yields for the long term.
Short-duration assets: With the yield curve continuing to steepen, spread tightening on the longer-duration side has led to better relative value in the front end. Risk-averse investors may benefit from higher-quality exposure, such as senior collateralized loan obligations, which offer attractive value compared with many fixed income asset classes.
Longer-duration assets: As yields moderate, investors have a short window to extend duration now.
Given uncertainty around rate-cut timing and equity volatility levels, using a barbell approach combining short- and longer-duration strategies may smooth the sequence of returns.
