It’s beginning to look a lot like 2024 – expect volatility and opportunities for bond markets in 2025
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Article Type
BondTalk
Topics
Credit, Banks, Long-Term Outlook, Opinion
Published
December 10, 2024
Read time
4 mins
Author
Iain Buckle
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Despite the strong showing of corporate bonds in 2024, volatility in the government bond space has left overall returns from fixed income markets somewhat short of what many investors expected for the year. Central Banks loom large as a key reason for this disappointment; while they have started to cut rates, they have not delivered what the market expected. Remember talk in January of six rate cuts by the end of the year? That optimistic outlook was speedily discarded as economies (mainly the US) proved to be more resilient than many anticipated. Throw in a significant amount of political upheaval and the turbulence in bond markets makes sense. Will 2025 offer similar volatility? 

 

The short answer is yes - we expect bond markets to remain volatile in 2025. The market currently expects a further 75bps of cuts from the US Federal Reserve over the next 12 months. The broader US economy still seems quite robust, however, and those 75bps of expected cuts could look optimistic if the labour market remains resilient. The political backdrop in the US will also drive volatility, given the market assumes a Trump presidency will lead to looser fiscal policy and higher inflation. We will learn more as he takes office, and the reality may not be what the market has implied. But it's likely the style of his presidency will only add to the uncertainty and volatility in markets. 

 

The outlook in Europe seems slightly more certain. Core European economies have been struggling for some time, negatively impacted by a weak Chinese consumer and growing competition from within China itself. We expect the ECB to continue to cut rates through 2025, with125bps of cuts expected by the end of the year. It would take a further deterioration in the outlook for the market to price-in further cuts, but that is certainly a possibility as we learn more about US tariffs early in 2025.

 

In contrast to interest rate markets, we do not anticipate material volatility in broad credit markets during 2025, at least not in the opening half of the year. The global macroeconomic outlook is suitably benign that it should not threaten the fundamental outlook for corporate bonds, especially for investment grade assets. Even for high yield we do not anticipate a meaningful increase in defaults. 

 

There are, of course, risks to any view and there are two in particular that currently warrant attention. The first is a material slowdown in global economies, most importantly in the US. The second is that the Fed no longer adopts a gentle cutting path. While the risk of the first concern has declined during 2024, the second outcome could materialise if the market starts to believe that Fed policy will be materially more restrictive than currently expected. This outcome, which could transpire in the second half of 2025, would not be taken well by risky assets. 

 

Economic developments aside, corporate bonds are undoubtedly expensive in spread terms (ie, the additional yield on offer compared to government bonds). Europe and the UK are perhaps a little bit cheaper, but even in these jurisdictions it is hard to see material upside from current levels. Nevertheless, there shouldn’t be much to upset credit markets, although we will likely see the market trade within a relatively tight range. Part of the reason for this modestly positive outlook is the ongoing strong demand for the asset class. The overall yield within credit remains appealing for investors and there remains a significant amount of cash sitting on the sidelines that we think will slowly start to make its way into other markets, including the bond market. 

 

There is little margin for error, however, and credit markets – like their government counterparts - are certainly vulnerable to changes in the macro backdrop as the year progresses. So expect 2025 to look a lot like 2024, particularly in the first half of the year. For investors, there will be opportunities to exploit in rates markets, both in terms of direction and cross-market performance. Meanwhile, broad credit markets will remain expensive but rangebound, supported by the ongoing demand for the attractive overall yield. 

 

Important disclosures

Author

Iain Buckle
Head of UK Fixed Income

Iain Buckle, head of UK fixed income, is responsible for overseeing all fixed income portfolios managed by Aegon AM UK. His portfolio management responsibilities focus on sterling and global investment grade portfolios.

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