Global bond valuations remain attractive

Central bank rate hikes in 2022 and 2023 helped drive bond yields higher, creating real value in global fixed income after over a decade of financial repression. Since 2023, 10-year bond yields have traded in a broad range of 4%-5% in the US and 2%-3% in Germany, and bond valuations—as measured by inflation-adjusted real yields, are compelling. However, as the US Federal Reserve (the Fed) restarts its rate cutting cycle, the window for investors to take advantage of attractive bond valuations may be closing.

Exhibit 1 shows that US and UK real yields are back to levels last seen before the global financial crisis (GFC), and in line with the ex-post inflation-adjusted real yield US Treasuries have offered over the past 100 years. Fixed income once again provides a good stream of real income, fulfilling its primary role in investors’ portfolios. 

Over the past few years, global inflationary pressures have cooled. Despite the recent increase in US inflation from tariffs, the outlook is for inflation to run near central bank targets. This expectation is supported by the easing seen in labour markets, particularly in the US, where employment growth has stalled. With inflation near target, central banks are now free to respond to negative growth shocks by cutting interest rates aggressively, allowing bonds to perform their secondary portfolio role: diversifying risky assets in a multi-asset portfolio.

The cyclical window of opportunity may be narrowing

These valuation arguments have been applicable since central banks started cutting rates in mid 2024. But it would be imprudent to believe they will persist indefinitely, due to rising cyclical risks. In particular, the slowing in the US labour market has caused the Fed to pivot its focus to downside growth risks rather than upside inflation risks. While job losses remain modest, the Fed can lower rates in a gradual manner towards 3%, but if job losses pick up (not our base case), investors should be prepared for aggressive rate cuts to well below 3%. Such a scenario could result in double-digit bond returns but would also slam the window shut on today’s attractive valuations.

Investors also need to be aware that the opportunity cost of waiting to invest is set to change.  Central banks have been running restrictive monetary policy to bring inflation down. And these high cash rates have generally been above longer-dated bond yields, giving investors an opportunity “gain” from waiting. This situation changed in Europe earlier in the year and is set to change in the US should the Fed cut rates one more time. With $7.31 trillion sitting in US money market funds[1], lower cash rates could unleash a powerful technical demand for fixed income.

Portfolio construction focused on diversifying sources of income

Gradual interest rate cuts in the US will help prolong the global economic expansion and ease financial conditions. While credit spreads are at the bottom of historical ranges, orientating around diversified sources of additional income is likely to continue to deliver excess returns for aggregate bond portfolios. We therefore see the current environment underscoring the importance of asset allocation, and we favour diversified carry-oriented strategies across corporate credit and securitised markets for attractive yields, while leveraging duration to hedge against tail risk scenarios.

In contrast to earlier this year, we prefer to own intermediate duration, rather than curve steepeners, as a way to hedge the downside growth risks should layoffs pick up. Valuations have changed and the curve has steepened. Short-dated bond yields are much lower now than earlier this year while concerns about high government debt levels have caused long-dated bond yields to remain elevated. 

We see increased risks that sovereigns respond to concerns about the volume of issuance by reducing the amount of long-dated bond issuance. More important, historical evidence suggests that duration outperforms cash when the curve between bonds and cash is steep (see Exhibit 2 and Exhibit 3).

Global relative value is orientated around underweighting eurozone duration, especially Germany, against global peers. German bond valuations are much less attractive than US and UK valuations. As Exhibit 1 shows, German real yields, adjusted for expected eurozone inflation, are still below pre-GFC levels, despite the fact that pricing for eurozone 10-year inflation has returned to pre-GFC levels.  Fundamentals and technicals are also headwinds for European fixed income. The forthcoming German fiscal stimulus will provide a boost to growth and inflation starting next year. And the increased bond supply will coincide with changes to Dutch pension regulations that will structurally reduce demand for long-dated bonds.

The re-pricing of global bond markets in 2022 and 2023 means that our diversified Global Aggregate portfolio gives investors a US dollar hedged yield of about 5.5% (approximately 3.3% in euro hedged terms) with an average A credit rating. The active interest rate positioning means we are less exposed to the more expensive European fixed income market and well positioned to deliver strong capital gains if US layoffs pick up, triggering more aggressive rate cuts from global central banks.

¹Source: ICI; data as of 24 September 2025.