The macroeconomic landscape of 2025 has been the definition of a rollercoaster ride. Markets have been unpredictable thanks to heightened geopolitical tensions, growth concerns, fiscal pressures and, of course, Trump’s now infamous Liberation Day.

So, how has all this turmoil affected fixed income strategies?

To find out, we invited three industry experts, Alexander Pelteshki from Aegon Asset Management, Michael Biemann from PIMCO and James Carter from W1M, to discuss the last six months and identify where the risks and opportunities currently lie in fixed income markets.

Key takeaways

• With continued heightened volatility, in addition to central bank policy divergence across the globe, fixed income investing currently demands a flexible approach.
• Targeting high-quality liquid assets, which will perform in a wide range of possible outcomes, is key.
• Fixed income has regained its role as a crucial diversifier in portfolios. Along with its potential for capital appreciation, now is a compelling moment to re-evaluate fixed income allocations.

Interpreting the macroeconomic environment

The macroeconomic backdrop has been incredibly volatile this year, with more major events seen in the first quarter of 2025 than typically seen in an entire year. Markets reacted accordingly, especially in the face of the potential inflationary impacts of tariffs, which led to rates markets selling off and good credit performance initially. However, this quickly pivoted to concerns around growth, prompting rates markets to rally and a sell-off in risky assets, which then subsequently recovered as the rhetoric around tariffs was somewhat tempered post liberation day. The picture surrounding US trade policy does remain highly uncertain, which has heavily impacted markets.

Looking ahead, markets will continue to oscillate between fiscal and inflationary impacts and back again towards growth concerns. As a result, investors will likely need to remain nimble and liquid but may also want to lean into higher-quality bonds, which will likely do better in a more challenging growth environment. Furthermore, concerns about U.S. fiscal policy are rising, with the largest peacetime deficit raising long-term debt sustainability questions. Elsewhere, regional inflation trends vary, with the UK expected to see easing inflation, while U.S. inflation may remain more entrenched given a high level of uncertainty.

Central bank divergence

Central bank policy is currently clouded by uncertainty too, with a mild U.S. recession possible, but moderate growth still the base case. A key risk is that the Federal Reserve may not get enough weak economic data, particularly from the still-strong labour market, to justify cutting rates aggressively this year. Markets currently expect around two U.S. cuts, but in reality fewer may materialise.

In Europe, the well-telegraphed increase in fiscal spending and milder economic weakness could also limit rate cuts. The uncertainty between market expectations and actual central bank actions highlights the complexity of the current policy landscape. For investors, it reinforces the need for flexibility and readiness to adapt portfolios to a range of outcomes amid shifting economic signals and diverging central bank paths.

Global markets

The UK terminal rate is priced similarly to the U.S., but structural challenges (for instance, Britain’s floating rate mortgage market and challenges to exports) may mean the UK’s terminal rate should look more like that of Europe’s. UK bonds are therefore appealing, especially if markets are underestimating future easing. The UK’s improved fiscal prudence, structural value on offer and recent gilt outperformance further support the case for domestic fixed income holdings.

In contrast, both long-dated U.S. Treasuries and German bunds face pressure due to waning structural demand from key buyers and those rising fiscal concerns, which warrants potential caution. In terms of credit, curves have flattened with headline spread levels tight on European and U.S. investment grade indexes, with less attractiveness in the long end of credit curves. Front-end credit, in the U.S. and Europe, therefore looks more favourable. Carefully selected emerging market high-yield debt also offers opportunities.

Beyond traditional bonds, securitised assets, such as U.S. agency mortgage-backed securities, stand out. They combine attractive yields, strong liquidity and virtually no credit risk, making them compelling in a tight credit spread environment. They can provide better compensation and room for active managers to find value during ongoing market dislocation, outside of traditional government bonds and corporate credits.

Portfolio positioning

With credit spreads tight despite elevated default rates with tighter financial conditions, taking a cautious approach to credit risk is appropriate. Focusing on active credit selection and capturing alpha through inefficiencies is possible, especially in selective high-quality and liquid holdings. Furthermore, through a reduced exposure to high yield and a tilt toward investment grade, portfolios may be defensively positioned, but overall yields remain attractive and, thanks to being liquid, it’s possible to capitalise on future spread widening or market dislocations that may occur in the next 6-12 months.

Management tools such as CDS hedges can protect against tail risk events, so it’s possible to balance income generation and capital preservation. That will be key, as will closely monitoring macroeconomic developments with a patient mindset, ready to act when the right opportunities arise.

Future risks

More so than ever, it’s vital to stay aware of overlooked risks in fixed income markets, especially now with heightened uncertainty surrounding the U.S. trade policy. Tariffs may well lead to persistent inflation and slower growth - raising the risk of stagflation and putting pressure on earnings and credit markets. Persistent inflation, possibly driven by continued fiscal spending, remains underappreciated by markets and leaves central banks with limited flexibility to cut rates. Furthermore, credit markets are not fully pricing in a potential U.S. recession.

If China successfully implements more fiscal stimulus and the ECB accelerates rate cuts, there may be opportunities in these markets. Without strong policy responses, however, equity markets could struggle. Europe faces the most significant challenges due to its reliance on external demand, particularly exports to the U.S., and the potential for trade frictions.

Finally, geopolitical tensions, such as the potential for Chinese aggression toward Taiwan, further heighten market risks, even if conflict isn’t imminent.

Diversifying a portfolio with Fixed Income

Fixed income is once again an appealing asset class thanks to a significant reset in yields, now offering healthier real returns than in the post-financial crisis era. Investors value fixed income as it can deliver on three fronts: steady income, relatively low risk and diversification benefits, which cushion portfolios during downturns. Though recent inflation disrupted the more typical negative correlation between equities and fixed income, fixed income is expected to regain its diversifying role.

Fixed income also has strong capital appreciation potential, particularly in long-dated UK gilts trading at deep discounts. Some gilts, for instance, offer risk-free returns that could rival equities if held to maturity.

Ultimately, while the current more favourable environment for bonds may not last indefinitely, it is a compelling moment for investors to reconsider the role of fixed income.

Important Information

This video was recorded in May 2025. This video is issued by Square Mile Investment Consulting and Research Limited (“SM”) which is registered in England and Wales (08791142) and is a wholly owned subsidiary of Titan Wealth Holdings Limited (Registered Address: 101 Wigmore Street, London, W1U 1QU).

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