Lead Portfolio Manager
It’s not often that bonds find their way into the main news headlines, but since the start of 2025, the significant rise in government bond yields has been a central focus. Yields across major developed markets, particularly in longer-dated tenors, have spiked during the turn of the year, led by the US.
DM yield moves since Q4 2024
Source: J.P. Morgan Asset Management, Bloomberg. Data as at 27 January 2025.
The reasons behind these moves are rooted in shifting sentiments regarding monetary policy, fiscal sustainability, economic trajectories, and some technical factors. However, yields have not risen uniformly, and the attractiveness of investment opportunities varies by region. We explore the fundamental backdrop in major developed economies to find where the opportunities exist.
Spread for government bonds over short term bills has become more attractive
Source: Bloomberg, J.P. Morgan Asset Management. Data as at 27 January 2025.
US valuations catch the eye
The fundamentals of the US economy remain sound and indicate a strong growth backdrop, even as President Trump's tariff policy is driving uncertainty in pockets.
The labour market continues to be benign and seems to be stabilising at a level that will not require meaningful, if any, further monetary policy easing. Inflation has been a central theme for fixed income investors, with the downside surprise in December monthly, core inflation triggering a reversal of the new year rate selloff. Core inflation measures have showed a disinflationary trend, offering much needed reassurance in the midst of debates about reacceleration risks and potential tariff impacts. The data now points towards a normalisation in inflation, with most of the consumption basket returning to pre-Covid levels.
Even though the strong growth outlook does not offer a compelling case for US duration, valuations have become interesting. The recent yield rises across the curve have sent real yields back to pre-GFC levels and the steepening has seen the term premium reach post-taper tantrum highs. The rise in term premium bolsters total return prospects for bonds and provides a cushion against capital loss.
Term premium at post-taper tantrum highs
Source: J.P. Morgan Asset Management, Bloomberg. Data as at 27 January 2025.Term premium is calculated as average of estimations from economists.
Interest rate trajectory in Europe remains supportive
Europe’s growth backdrop is clearly sluggish compared to the US. However, the downward trajectory of inflation is clearest in the eurozone than any other major developed market. Our base-case expectation is for the European Central Bank (ECB) to continue easing in its next two meetings, which should be supportive for duration. While valuations look attractive in the UK, we believe fundamentals warrant caution due to the uneven disinflation story and still high wages.
Outside of duration, we also see opportunities in eurozone sovereign spread, and anticipate Italy and Spain to outperform their peers. Italy offers the highest yield, has solid fundamentals, and enjoys stable political conditions. Spain, with its strong fundamentals and relatively tight spread, is also expected to do well.
On the other hand, France faces ongoing political uncertainty with upcoming elections, and Germany's scarcity premium is diminishing as its deficit widens.
Elsewhere, we are constructive on Australia as inflation data supports rate cuts as soon as February, and the yield curve remains relatively steep compared to other markets. In contrast, we maintain a cautious stance on Japan, viewing it as a structural underweight due to its significantly lower real yields compared to other regions.
Japanese real yields lag behind peers
Source: Bloomberg, J.P. Morgan Asset Management. Data as at 27 January 2025.
Portfolio positioning
Overall, we think the market volatility and divergence in fundamental backdrop across developed markets offer a wide range of opportunities over H1 2025. Our global rates portfolios are underweight US duration relative to Australia and overweight US real yields due to compelling valuations.
To recognise the downside risks to market’s pricing of ECB interest rates amid steady disinflation and uninspiring growth backdrop, the portfolios are overweight eurozone duration in the belly of the curve with a curve steepening bias. We also have a bias for high quality carry, via Spain, Italy (front end), and high quality government guaranteed bonds. Over the coming months, we look to position dynamically as we navigate the volatility.
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