Central bank easing cycle to provide support
During 2024, most major economies experienced a moderation in inflation, slowing economic growth, and rising unemployment. Accordingly, with most central banks confident that inflation is falling, many have commenced cutting interest rates, with a greater focus now on labour market weakness and economic growth risks.
Globally, given monetary policy remains restrictive with real interest rates notably positive, we expect interest rates to continue to fall in 2025. Greater fiscal looseness, particularly in the US following Donald Trump’s re-election, could lead to increased volatility in long-maturity bonds - although we expect this to be supressed. Putting this together, we favour duration and will seek to add on moves higher in yield, though remain selective on curve positioning.
We maintain a cautious stance on credit and riskier assets, primarily due to heightened valuations, although we will look to add during periods of volatility.
In summary: we believe that interest rates and bond yields are likely to move lower, and abundant liquidity conditions will likely remain, encouraging a mindset of ‘buying dips’ in higher risk assets.
Fixed Income offers the potential for attractive returns and diversification benefits
Recent returns in fixed income markets have been impressive, with global bond markets returning over 6% and global credit markets returning over 7% in the 1 year to November 20241. With yields continuing to remain significantly higher than historical averages, we expect fixed income markets to continue to offer the potential for attractive returns whilst providing defensive and diversification benefits. As highlighted in Figure 1, compared to the average over the past 20 years, current global bond yields and current global yields are both 40% higher.
These elevated yields are particularly attractive against the current backdrop of moderating inflation and central banks commencing interest rate cuts. Early in an easing cycle, fixed income allows investors to lock in higher yields while also providing the potential for additional capital return as yields fall.
Figure 1: Average yield-to-maturity* across fixed income markets
Source: Bloomberg
Past performance is not a reliable indicator of future performance. The following indices have been used to represent the different parts of the fixed income investment universe above: Global bonds – Bloomberg Global Aggregate Index; Global investment grade corporate - Bloomberg Global Aggregate Credit Total Return Index. *Yield-to-maturity is the return that would be earned over the next year if there were no changes to interest rates and assuming there are no changes to the underlying investments. Average yield-to-maturity has been calculated as the average of the monthly yield-to-worst over the last 20 years to 31 December 2024.
Chart takeaway
Yields on both global bonds and global credit offer attractive value versus the 20 year historical average. Against a backdrop of moderating inflation and central bank easing, we expect fixed income markets may offer attractive returns to investors in 2025.
Buying the dips in credit markets
While spreads are already tight, a number of positive factors are expected to see credit trade in a relatively narrow range in the medium term. With monetary and fiscal policy set to provide more support to the growth outlook than was earlier expected, fundamentals should be supported. Moreover, while spreads are tight, all-in yields remain high relative to history, and expectations of positive total returns should drive demand.
Accordingly, while we remain somewhat cautious on credit due to current heightened valuations, we will seek to add on volatility, with a mindset of ‘buy the dips’ in higher risk assets. High yield bonds and subordinated debt may appeal to investors seeking higher relative income, particularly when attractive valuations emerge.
Opportunities present as potential for global divergence increases
Diverging economic conditions and monetary policies across regions are creating opportunities for fixed income investors, particularly for active strategies. As some central banks undergo rate cutting cycles, others are increasing them, while some remain on hold.
Australia lags behind most developed markets in terms of interest rates peaks and continues to face persistent underlying inflation. The RBA has resisted cutting rates in 2024, but with the country already in a per-capita recession, the outlook points to Australia eventually falling in line with other developed countries through rate cuts. In the meantime, Australian bonds offer the potential for an attractive yield profile and return outlook.
In credit markets, spreads remain relatively tight. However, differing economic backdrops across countries and sectors present selective opportunities. US and Australian corporate credit remain preferable to Europe and the United Kingdom. Episodes of market volatility, driven by ongoing uncertainties, are expected to present additional opportunities for flexible fixed income investors.
These examples of flexible fixed income investment opportunities can be captured within the Macquarie Dynamic Bond Fund Active ETF (Managed Fund) and the Macquarie Income Opportunities Fund Active ETF (Managed Fund).
The Target Market Determination (TMD), available at macquarie.com/mam/tmd, includes a description of the class of consumers for whom the Fund is likely to be consistent with their objectives, financial situation and needs.
Brett Lewthwaite
Global Head of Fixed Income
Explore the full report to see our views on the year ahead.
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