Turning the tides—central banks' new era of rate cuts

Executive summary

There is a lot to pay attention to in fixed income markets. Recent developments include Donald Trump’s win in the US presidential election as well as the US Federal Reserve’s (Fed’s) continued easing of monetary policy with a 25-basis point (bp) cut in November, catching up to European Central Bank’s (ECB’s) total of 75 bps of cuts. Continued disinflation has opened the door for future rate cuts in both areas. The market is living from data point to data point, causing significant volatility in US Treasury (UST) yields.

We continue to call for a cautious stance on fixed income sectors as most spreads are hovering around 20-year lows. We still prefer high-quality, shorter-maturity assets that have attractive yields, which lessen the impact of spread widening.

In this issue, we look closely at the following themes and provide our outlooks for fixed income sectors:

Portfolio themes

• The long and bumpy road: Looking at investment-grade corporate bond spreads.
• What economic impact can we expect from Trump’s win: President-elect Donald Trump’s proposed tariffs could be a wild card for the US economy.
• Fed: Playing with sharp objects? As the Fed tries to steer the economy toward a soft landing, there have been significant swings in the market around the number of rate cuts by the end of the year.

Overall risk outlook

We maintain our “neutral with reason for concern” outlook on overall risk. Spreads across most sectors are at or near 20-year lows, and we find it hard to identify catalysts for much additional spread tightening. In our view, this has left a risk-asymmetric profile, where the potential downside of widening spreads outweighs the likelihood of tightening. This does not mean we are not invested in spread products. Despite tight spreads, there are opportunities to pick up potential returns from interest-rate carry positions in shorter-maturity, higher-quality assets. By managing our exposure to spread movements, we think we can limit the downside of any material spread widening. Geopolitical risk, either in the form of increased tensions in the world or the US elections, is still an overhang to fixed income spread sectors.