Fixed-Income Outlook 2025: Fertile Ground

Growth: Anticipating the Known Unknowns

We expect global growth to fall short of consensus expectations in 2025. Diverging growth will likely drive how much further interest rates fall in each region, with yields potentially falling more in Europe, for example, than in the US.

European economies, struggling to return to meaningful growth post-pandemic, are most vulnerable to an external shock that could push the region into recession. Existing challenges—both structural and geopolitical—could be exacerbated by new uncertainties, such as snap elections in Germany and the policies of the incoming US administration. We think these challenges could result in slower growth, deeper rate cuts and further yield declines than the market currently expects.

Meanwhile, we think that President-elect Trump’s policies may result in higher US nominal growth and inflation, and fewer cuts than previously expected by the US Federal Reserve. In fact, in the weeks surrounding the US election, US bond yields climbed sharply, reflecting speculation that Trump’s policies could lead to higher inflation and a widening federal deficit.

In China, policymakers have taken meaningful steps to support the economy, including rate cuts and a recent 10 trillion yuan ($1.4 trillion) debt package, but we view these as designed to manage the pace of the slowdown, not to push growth into a faster trajectory. China is also vulnerable to a trade conflict with the US.

Until we have clarity on the tariffs, taxes and other policies of the Trump administration, speculation and rate volatility are likely to persist. In our view, investors should get comfortable with evolving policy expectations and data surprises and avoid getting swept up in short-term turbulence. Broader trends, such as moderate global economic growth and high yields, matter more.

Yields: Going with the Flow

Predicting the direction of bond yields over the near term is challenging. Our focus remains on the intermediate term, and we think that’s where investors should focus too. Historically, yields have declined as central banks have eased. Thus, in our view, bonds are likely to enjoy a price boost as yields trend lower in the coming two to three years in most regions.

Demand for bonds could be exceptionally strong given how much money remains on the sidelines seeking an entry point. As of October 31, a record $6.9 trillion was sitting in US money-market funds, a relic of the “T-bill and chill” strategy popular when central banks were aggressively hiking interest rates. Now that central banks are easing and money-market rates are declining, we anticipate roughly $2.5 to $3 trillion will return to the bond market over the next few years.

Yield Curves: Under the Influence

The yield curve is a snapshot of investors’ current expectations for future economic conditions. Thus, the influences on the short end of the curve differ from those on the long end.

Central bank policy steers the short end of the curve, so investors focus on the latest jobs and inflation data. In the intermediate range—between two and 10 years—economic growth is key. For the longest maturities, long-term inflation and fiscal strength matter. Today, speculation is particularly high around long-term yields, thanks to growing national debts worldwide.

As a result, yield curves have already begun to steepen. We see room for further steepening as central banks continue to ease and bigger term premiums get priced into longer-dated yields due to concerns about national debt levels.

In the US, we expect the slope between five-year and 30-year bonds to increase most. Historically, when the Fed eased, this part of the curve steepened significantly, driven partly by recessionary environments. This time around, this slope has steepened but is still below historical averages (Display). In Europe, the slope between two-year and 10-year bonds may steepen most.

Historical and current analyses and forecasts do not guarantee future results.
Historical average since January 1, 1990
Through December 31, 2024
Source: Bloomberg, US Federal Reserve and AllianceBernstein (AB)

Credit: Fundamentally Sound

Though credit spreads are historically tight, yields across credit-sensitive assets remain near historic highs. Investment-grade corporate fundamentals are still in good shape, having started from a position of historic strength. High-yield issuers also have generally robust fundamentals and are enjoying continued strong demand. Also, falling rates should help relieve refinancing pressure on corporate issuers. Thus, we remain cautiously optimistic, as spreads could remain rangebound for an extended period.

That said, we don’t think changes in policy will weigh on all industries and companies evenly. For example, energy and financials are likely to face less regulation. Conversely, import-reliant industries such as retail could be challenged. Overall, we expect investment-grade issuers with the strongest financials to be relatively resilient to tariff pressures.

Seven Strategies for 2025

Get invested. We believe investors seeking an entry point into the bond market should take advantage of the recent backup in yields. Those still on the sidelines risk missing out on potential price gains as bond yields decline. Money-market yields closely track central bank actions, so they’re likely to fall even further, but with no price bump to compensate.

Extend duration. If your portfolio’s duration, or sensitivity to changes in interest rates, has veered toward the ultrashort side, consider lengthening it. As interest rates decline, duration benefits portfolios by delivering bigger price gains. Government bonds, the purest source of duration, also provide ample liquidity and help to offset equity market volatility.

But don’t just set your duration and forget it. When yields are higher (and bond prices lower), lengthen the duration; when yields are lower (and prices higher), trim your sails. And remember: even if rates do rise from current levels, high starting yields provide a cushion against the negative price effect.

Think global. Idiosyncratic opportunities increase globally as the extent and degree of central bank easing diverges, and the advantage provided by diversification across different interest-rate and business cycles is more powerful.

Hold credit. Despite narrow spreads, credit-sensitive sectors remain attractive, in our analysis. Spreads would have to widen dramatically from current levels to offset today’s compellingly high yields. That said, current conditions demand careful security selection. Changing policies and regulations won’t affect industries and companies uniformly, nor will weak economic growth.

Evolving approaches to security selection could help investors more objectively analyze large swaths of the credit universe and may help increase alpha. We also think it makes sense to underweight cyclical industries, CCC-rated corporates—which account for the bulk of defaults—and lower-rated securitized debt, because these are most vulnerable in an economic slowdown. A mix of higher-yielding sectors across the rating spectrum—including corporates, emerging-market debt and securitized assets—provides further diversification.

Adopt a balanced stance. We believe that both government bonds and credit sectors have a role to play in portfolios today. Among the most effective strategies are those that pair government bonds and other interest-rate-sensitive assets with growth-oriented credit assets in a single, dynamically managed portfolio.

This pairing takes advantage of the negative correlation between government bonds and growth assets and helps mitigate risks outside our base-case scenario of moderate growth—such as the return of extreme inflation or an economic collapse. Combining diversifying assets in a single portfolio makes it easier to manage the interplay of rate and credit risks and to readily tilt toward duration or credit according to market conditions.

Protect against inflation. We think investors should consider increasing their allocations to inflation strategies, given the heightened risk of future surges in inflation, inflation’s corrosive effect and the affordability of explicit inflation protection.

Complement with a systematic approach. Today’s environment also increases potential alpha from security selection. Active systematic fixed-income approaches may help investors harvest these opportunities. Systematic strategies rely on a range of predictive factors, such as momentum, that are not efficiently captured through traditional investing. Because systematic approaches depend on different performance drivers, their returns may complement traditional active strategies.

Finding the Silver Lining in Volatility

We think investors should get comfortable with evolving policy expectations and short-term turbulence, while positioning portfolios to take advantage of opportunities created by heightened volatility and market tailwinds in the coming months.

Above all, keep an eye on broader trends, such as moderating economic growth, high starting yields, pent-up demand and declining interest rates. And remember that money-market yields, which change daily, should continue to fall as central banks cut interest rates. To us, this signals it’s high time to get back into bonds.

This is a favorable environment for bond investors—especially for those who can beat the eventual rush back into bonds. As we see it, today’s conditions are fertile ground for bond investors.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.