As the dust settles on a consequential election year, investors will need to separate credible policy promises from the bluster of political rhetoric.

In the US, potential deregulation and tax cuts could support business sentiment and boost growth. However, tighter controls on immigration, punitive tariffs, and sizeable fiscal expansion at a time of full employment could push inflation higher. The scale of the economic impact will depend on the size, scope, and sequencing of the actual policies pursued by the second Trump administration. If history is a guide, the bark is often worse than the bite, given the checks and balances of the legislative body and other legal mechanisms.

To this end, elevated political and policy uncertainty could keep interest rate markets volatile as market participants continuously reassess the outlook for inflation, growth, and monetary policy on the back of a potentially dynamic government agenda. 

As it stands, the US economic outlook appears benign. Growth remains solid and the labour market robust, albeit with some signs of softening.

With inflation generally benign, the path to further rate cuts will likely depend on developments in the labour market. Further weakness could trigger the US central bank to adjust rates lower. Otherwise, the Fed will likely proceed cautiously in our view, as they await further clarity on the Trump administration’s policies, which, on net, appear modestly hawkish for growth and inflation.

Barring significant weakness in the labour market, the current easing cycle could prove to be relatively shallow. As illustrated in the chart, market participants have already trimmed their expectations of future rate cuts, expecting interest rates to stay higher for longer, on the back of a stronger economy and stickier inflation. 

Nevertheless, the bar for raising policy rates is high, and we believe the Fed could retain a cautiously dovish posture, choosing between slowing the pace of rate cuts or keeping policy settings unchanged. Against the backdrop of a resilient US economy, this still provides a constructive setup for fixed income, in particular credit.

As illustrated in the chart, yields remain relatively attractive across core and extended bond sectors, hovering well above the median of the last decade and, in some sectors, trading at the upper end of historical ranges. Moreover, higher starting yields tend to correlate with higher forward returns⁴ and this could present an attractive opportunity to lock in elevated yields.

As it relates to specific sectors, we are constructive on securitised² credit, including agency mortgage-backed securities (Agency MBS) and commercial MBS (CMBS), on account of higher yields and more attractive valuations versus other corporate credit sectors. Elsewhere, we continue to find opportunities in high yield³ and investment grade corporate credit even as credit spreads trade at the tighter end of historical ranges. This broadly reflects stronger fundamentals amid a healthier outlook for revenues and earnings. Nevertheless, higher valuations argue for more judicious bottom-up security selection and active management to navigate potential bouts of rate and credit spread volatility.

Given lingering uncertainty in the fiscal and monetary policy outlook and elevated volatility in the rates market, we remain tactically cautious on duration¹. If future policy actions lead to a resurgence of inflationary pressures, long Treasury positions could exacerbate portfolio volatility as the Fed adopts a more hawkish posture. Conversely, in the event of an economic downturn, Treasuries can act as a ballast for portfolios during a flight to safety.

We believe the balance of risks tends toward the former as the general direction of the Trump administration’s policy agenda appears inflationary. This underpins our more cautious stance on duration¹. As can be gleaned from the chart, staying short duration¹ can help buffer against potential downside risks should inflation reheat and interest rates move higher. Nevertheless, potential back up in long-term yields could present opportunities to increase duration¹ as a buffer against growth risks, should economic data point to a weaker outlook.

More importantly, in the face of elevated inflation, fiscal and monetary policy uncertainty, staying nimble and active will prove critical to optimise duration exposure so as to mitigate volatility and build portfolio resilience.