The days of the zero lower bound and negative yields have become a distant memory, allowing bonds to regain their rightful place in portfolios as both an attractive source of income and portfolio diversifier.
However, the macroeconomic landscape presents challenges, with political and fiscal uncertainties under a new US administration potentially affecting growth, employment, and monetary policy, thereby stoking market volatility.
While the fixed income market is rich with opportunities, such challenges mean investors may have to seek risk-adjusted returns in a prudent fashion. We believe diversified active fixed income strategies, that have outperformed the benchmark index in the long term1 can help investors achieve their goals.
Active strategies may help investors manage interest rate risk by dynamically adjusting duration positioning3 while rigorous bottom-up research can help pinpoint quality assets across various sectors. Such strategies typically have a relatively greater chance of withstanding the vagaries of fast-changing market cycles.
Navigating Trump 2.0
Post the COVID-19 crisis, the US economy has surged ahead of its developed peers, exhibiting stronger growth and more robust financial markets. Under a second Trump administration, American exceptionalism is likely to continue, as deregulation and tax cuts sustain economic momentum by boosting business sentiment and growth. However, tariffs, restrictive immigration policies, and fiscal expansion amid full employment may stoke inflationary pressures.
The net economic impact will hinge on the size, scope, and timing of these policies. Historically, legislative checks have often tempered policy impacts, but this is not guaranteed. Balancing these risks will be key.
Nevertheless, political and policy uncertainty may keep interest rate markets volatile as participants reassess the implications to inflation, growth, and monetary policy amid a dynamic government agenda.
Prepare for a shallow easing cycle
While there are some signs of softening, the US economic outlook appears stable , buttressed by a relatively solid labour market and resilient consumption spending. With inflation closer to the 2% target, further rate cuts will likely hinge on developments in the labour market. If labour market conditions weaken, the Federal Reserve (Fed) may lower rates; otherwise, it will likely proceed cautiously, awaiting clarity on the Trump administration's policies, which appear modestly hawkish for growth and inflation.
Absent significant labour market weakness, the easing cycle might be a shallow one. As illustrated below, market participants have already reduced expectations for future rate cuts, anticipating higher rates for longer due to a strong economy and persistent inflation. However, any rise in long-term yields could present opportunities to increase duration as a buffer against growth risks if economic data weakens.
The threshold for raising rates is high, and the Fed may maintain a cautiously dovish stance, either slowing rate cuts or keeping policy unchanged. Against this resilient economic backdrop, credit becomes attractive, especially securitised paper4, due to relatively attractive valuations and higher yields5. Large parts of the credit market aren’t accessible via passive funds. There are also select opportunities in high yield and investment-grade corporate credit, despite tight credit spreads, reflecting stronger fundamentals and a healthier outlook for revenues and earnings.
The case for active management
When investing in fixed income, investors should consider interest rate sensitivity, credit risk, liquidity, market inefficiencies, and portfolio concentration in heavily indebted issuers. While passive strategies may absorb these challenges, active managers can navigate them more effectively.
Active management allows investors to explore market areas overlooked by passive strategies, uncovering more alpha opportunities. For example, high-yield corporates and non-agency mortgage-backed securities are excluded from passive indices, while asset-backed and agency securities have limited exposure. A large part of the growing securitised market is completely excluded6.
The Bloomberg US Aggregate Index, often seen as a representation of the US bond market, excludes about 47% of the US$53 trillion US public bond market5. These inefficiencies have allowed active managers to seek alpha. Net of fees, the average annualised returns of active core and core plus managers2 have exceeded the Bloomberg US Aggregate Index over the trailing 3-, 5-, and 10-year periods1.
Staying agile and active is crucial for optimising duration exposure, mitigating volatility and building portfolio resilience to navigate a constructive yet volatile market landscape.
J.P. Morgan Asset Management has a history of doing just that. It has navigated a complex and rapidly changing macro environment, delivering competitive returns, relatively attractive income, and lower volatility7.
1. Source: Simfund, J.P. Morgan Asset Management analysis; Data as of 31.07.2024. Analysis includes mutual funds in the Morningstar intermediate core and intermediate core plus categories with a primary prospectus benchmark of the Bloomberg US Aggregate Bond Index. Only includes primary share classes as defined by Morningstar. Past performance is not indicative of future returns.
2. Core-plus bond vehicles invest primarily in investment-grade US fixed-income issues including government, corporate, and securitised debt. However, they generally have greater flexibility than core offerings to hold non-core sectors such as corporate high yield, bank loan, emerging markets debt, and non-US currency exposures.
3. Duration is a measure of the sensitivity of the price (the value of the principal) of a fixed income investment to a change in interest rates and is expressed as number of years.
4. Securitisation is the process in which certain type of assets, such as mortgages or other types of loans, are pooled so that they can be repackaged into interest-bearing securities. Examples of securitised debt include asset-backed securities and mortgage-backed securities.
5. High-yield credit refers to corporate bonds which are given ratings below investment grade and are deemed to have a higher risk of default. Yield is not guaranteed. Positive yield does not imply positive return.
6. Source: Bloomberg, Securities Industry and Financial Markets Association, Bank of America. Figures reflect the most recently available data as of 31.03. 2024. Some figures may be lagged. Core and core plus fixed income strategies do not typically include tax-free municipal securities. IG Corporates refers to investment-grade corporate debt.
7. Source: J.P. Morgan Asset Management, Morningstar, Bloomberg. Data as of 31.12.2024. Past performance is not indicative of future returns.
