The backdrop for global fixed income has changed meaningfully. Yields have moved higher as investors contend with persistent inflation, elevated government borrowing, and uncertainty around the path for interest rates. But that repricing has also created a more attractive starting point for bond investors.
Higher starting yields provide greater income and a larger cushion against further increases in rates, while a still-resilient global economy continues to create opportunities across credit markets.
A more attractive opportunity at the front end
In September, the Federal Reserve raised interest rates for the first time since 2023, increasing its target range by 25 basis points to 3.75-4.00%. The decision, alongside updated economic projections, reinforced a picture of an economy that remains resilient even as inflation continues to run above the Fed's target.
For investors, the question is no longer simply whether the Fed will hike. It is how much additional tightening is already reflected in bond prices.
Markets continue to price additional tightening over the coming months. That is broadly consistent with our expectations and, if anything, somewhat more tightening than we anticipate.
That creates what we believe is an increasingly attractive risk-reward proposition at the front end of the US yield curve. Two- to three-year Treasuries offer yields well above cash and three-month Treasury bills, providing a meaningful cushion against further increases in rates. Yields can rise further without necessarily producing a negative total return.
With considerable additional Fed tightening already reflected in market pricing, that creates an attractive asymmetry. Investors are being paid to wait and do not necessarily need rates to fall to generate positive returns.
The long end may behave differently
In previous cycles, investors often relied on long-duration government bonds as a natural hedge against a growth shock. We believe the starting point today is different.
The US is running a fiscal deficit of roughly 6% of GDP despite an economy that remains relatively strong, creating substantial ongoing Treasury financing needs. Against that backdrop, the long end may not provide the same degree of protection it has in previous cycles, when deficits and government borrowing needs were considerably smaller.
The front end, by contrast, may offer a cleaner hedge against weaker growth. A deterioration in the outlook would likely make the Fed less hawkish and could eventually cause it to reverse course, with changes in the expected path of monetary policy reflected most directly in shorter-term yields.
The AI investment boom is changing credit markets
At the same time, competition for capital is increasing.
Government borrowing requirements are already elevated, while the private sector is entering a more capital-intensive phase. The artificial-intelligence investment cycle is an important part of that story.
Until recently, much of the investment in AI infrastructure was financed through the substantial cash flows and equity valuations of the largest technology companies. As those financing needs are increasing, companies are incrementally turning to debt markets to fund that investment.
The hyperscalers have already become significant issuers of longer-dated investment-grade bonds, and we expect financing to broaden further across corporate bonds, loans and securitised credit.
This investment is supportive of economic growth, but for bond investors it also means the public and private sectors are increasingly competing for the same capital. Against an already-heavy backdrop of Treasury issuance, that competition could continue to put upward pressure on longer-term yields.
While we remain constructive on the economic benefits of the AI investment cycle, we are also conscious of the concentration of capital and investor attention around the theme. That makes diversification increasingly important. We continue to look beyond the direct beneficiaries of the US AI buildout for return drivers that may behave differently across a range of economic and market outcomes.
Where are the opportunities?
We remain constructive on credit, supported by resilient growth and generally healthy corporate fundamentals. With spreads relatively tight, however, we believe returns will increasingly depend on where investors take risk rather than simply adding broad credit exposure.
Commercial real estate has been a favoured area within securitised credit, where depressed valuations and an improving fundamental backdrop created attractive opportunities. Following a meaningful recovery and tightening in spreads, however, valuations are less compelling today and we have become more selective.
We continue to see opportunities in parts of the high-yield corporate bond and bank loan markets. The AI investment cycle is providing a meaningful impulse to the real economy through increased capital expenditure, infrastructure development, and power demand. We believe those tailwinds should continue to benefit areas such as utilities and energy that are directly exposed to the buildout.
At the same time, we believe it is important to diversify beyond the direct US AI investment cycle. European corporate credit and emerging-market debt provide exposure to different economic drivers, industries, and policy regimes, broadening the sources of return within a global fixed income portfolio. With uncertainty around both economic and policy outcomes, that diversification can help build a more resilient portfolio across a range of scenarios.
The opportunity in today's bond market
Yields remain elevated, providing a strong starting point and a healthy cushion for bond investors. At the same time, credit spreads are relatively tight, meaning investors do not necessarily need to reach for risk to build an attractive and resilient portfolio.
In our view, today's environment allows investors to maintain a relatively high-quality, shorter-maturity portfolio while still earning attractive yields. Within US rates, we continue to favour the front end of the curve. Within credit, we remain invested but selective, combining exposure to areas benefiting from resilient US growth and the AI investment cycle with opportunities in European corporates, emerging-market debt, and other sectors that provide diversifying sources of return.
Rather than relying on a single economic outcome or investment theme, we believe that mix of exposures can create a more resilient portfolio across a range of outcomes.
The Fed may not be finished raising rates. But at today's yields, investors don't need it to be.
Eric Souders is a director and portfolio manager of the Payden Global Income Opportunities Fund at Payden & Rygel, a specialist investment manager partner of GSFM Funds Management, a sponsor of Firstlinks. The information in this article is provided for informational purposes only. Any opinions expressed in this material reflect, as at the date of publication, the views of Payden & Rygel and should not be relied upon as the basis of your investment decisions.
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