(MENAFN- Weber Shandwick) Dubai, United Arab Emirates - 21 January 2025 – The case for the fixed-income asset class is the strongest it has been for years, according to Invesco’s 2025 outlook (link here). The new macroeconomic backdrop has created many more opportunities to generate returns across the fixed-income landscape, with the potential peak in interest rates enabling investors to lock in a higher level of income for the years to come.
Investment-grade credit
Investment-grade credit spreads are now near or at their all-time tights. However, on an all-in yield basis, the asset class is still trading at levels not seen since the Global Financial Crisis (GFC).
Global investment grade credit in aggregate offers 90 basis points (bps) of spread. Excluding the Covid period, the range over the last 10 years has been 90-200 bps. Whilst there are some small differences between regions, spreads are unlikely to narrow any further in 2025. Returns will be driven by the income or ‘carry’ on the asset class and interest rate effects, as central banks are still expected to ease monetary policy.
The reasons for this tight pricing are twofold. First, the macro environment is currently conducive to risk-taking. Economies are broadly stable, corporate earnings have been healthy, and the risk of recession seems low. Inflation and interest rates are coming down, while stock markets have risen sharply again.
Second, the demand for bonds is very strong. 2024 was a significant year for supply, but far from pushing credit spreads of existing bonds wider, the supply of new bonds has been digested very well in an environment of spread tightening. Demand for most new issues is well ahead of supply, and there is precious little new issue premium.
“With risk premia compressed, this is a good time to be adding higher-quality borrowers that may be less immune to an increase in market volatility,” said Lewis Aubrey-Johnson, Head of Fixed Income Products at Invesco. “This includes senior bank securities, consumer staples issuers, and high-quality real estate operators. We have also been taking selective positions in emerging-market sovereign and government-related issuers, where spreads are relatively generous for the credit quality.”
High-yield credit
The outlook for European high yield is shaped by the macroeconomic environment, the general financial health of borrowers, and market pricing.
The economic environment in Europe is subdued without being especially worrisome. Growth is close to flat, business investment has been relatively weak, employment growth is slowing, and several countries have fiscal deficits. Nonetheless, inflation and interest rates are coming down, boosting real incomes and spending power. There are also tentative signs of a cyclical upswing. These factors should contribute to a small improvement in growth in the region this year.
“Rather than macro or credit quality, the greatest challenge to high-yield credit today is market pricing,” said Thomas Moore, Co-Head of Invesco Fixed Income Europe. “As yields have fallen, we have gradually shifted towards better-quality issuers and kept cash and other liquid securities in case of any unforeseen market volatility. Overall, whilst cognisant of the risks, we are optimistic about the prospects for the European market this year.”
In the US, fundamentals for high-yield credit are strong, with healthy balance sheets, upgrades exceeding downgrades, and a declining default rate. Moderation across many fronts (growth, inflation, and monetary policy) provides an ideal backdrop. A Fed biased towards more aggressive rate cuts, if necessary, provides a better floor for risk. Building on the momentum from 2024, strong demand for high yield is expected to continue, given the attractive all-in yields and the soft-landing base-case scenario for the economy.
“We see opportunities in the energy sector, specifically midstream,” said Niklas Nordenfelt, Head of High Yield at Invesco. “More dispersion is building within the retail sector amid consumer concerns and shifts in spending patterns, which leads to opportunities. Finally, the build-out of AI data centres should benefit the utility sector, communications issuers with fibre assets, and issuers engaged in cooling and connectivity components. Key risks include a stronger-than-expected economy leading to higher treasury yields, which would further challenge housing, construction, and companies with excessive debt, whereas an economic downturn would likely challenge valuations.”
Emerging-market local debt
The backdrop for emerging-market local debt is favourable as continued monetary easing by the US Federal Reserve enables further easing by emerging-market central banks, in turn boosting their domestic growth. Nominal and real interest rates have remained elevated in emerging markets, while disinflation has generally continued, offering attractive interest rate differentials versus developed markets. In addition, the normalisation of yield curves globally as well as diverging growth and inflation dynamics across individual countries create compelling total return opportunities.
“While key risks include volatility around US policy uncertainty and potential currency impacts, this is amidst a positive external environment of loosening monetary policy globally, the prospect of additional stimulus from China, and lower oil prices,” said Hemant Baijal, Head of Multi-Sector Portfolio Management at Invesco Global Debt. “Overall, we see a promising opportunity for generating alpha.”
Government bonds
The European Central Bank (ECB) is predicted to lower interest rates below market expectations, depending on the scale of the trade tariffs imposed by the new administration. A lower interest rate environment should be positive for bond valuations, but there are several headwinds to negotiate in 2025. The rates are still in the restrictive territory and far too high to support growth in the region.
The outlook for UK government bonds in 2025 is positive due to attractive valuations and an expectation that the Bank of England (BoE) will lower interest rates further than the market currently predicts.
“The European bond market has a broadly positive outlook for 2025 as we see some attractive opportunities,” said Gareth Isaac, Head of Multi-Sector at Invesco Fixed Income. “However, there is likely to be disparity between the performance of individual countries.”
US government bonds are expected to yield returns comparable to T-bills, albeit with higher volatility. This indicates that while the potential for gains exists, investors should be prepared for more significant fluctuations in bond prices.
“A key risk we need to manage in this environment is the inflationary impact of potentially expansionary fiscal policy in an already tight labour market,” said James Ong, Senior Portfolio Manager at Invesco Fixed Income. “Increased government spending could drive inflation higher, which could lead to volatility in interest rates. By staying vigilant and responsive to these developments, we can better navigate the complexities of the interest rate environment and make informed decisions to optimise our portfolios.”
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