Bond market volatility presents more opportunities for multi-asset investors

Central bank policy, rising geopolitical tensions and escalating concerns around the global macroeconomic backdrop have together caused considerable equity market volatility as well as a significant repricing in the fixed income universe.

From December to mid-January 2025, US bond yields climbed steadily and 10-year US Treasury yields reached 4.80% - their highest level since October 2023¹ . Since then, amid a range of political uncertainties weighing on growth prospects, they have fallen back.

More recently, Germany’s announcement that it would overhaul its debt policies to allow for increased defence spending saw German Bund yields soar, while the White House’s rhetoric and actions around trade tariffs and tax cuts have markedly impacted markets. 

Monetary policy, of course, has an ongoing impact on bond prices, and anticipation around future interest rate movements continues to do so - especially in the US, where inflation remains sticky and economic data has been softer.

However, with volatility comes opportunity and certainly the bond market upheaval could ultimately prove to be a boon for multi-asset investors given the dynamic nature of this asset class – which offers attractive compound income returns and can act as a hedge against volatile equity markets. This relationship has historically formed the base of the 60:40 and other multi-asset investment strategies.

High income

Higher yields, relative to the 2010-2020 period, are a good thing for investors as they raise the probability of decent returns across the asset class going forward. And certainly, they bode well for income seekers.

In the period following the 2008-2009 global financial crisis, central bank policy – low interest rates and quantitative easing – drove fixed income prices higher. But while asset prices were high, income levels were in the doldrums.

Today however, interest rates are much higher and therefore so is the carry (coupon) income; there is much greater income to be had currently from not only government bonds, but also from credit, investment grade and high yield bonds. Investors can benefit from the stability and liquidity of US Treasuries (even though recent events have showcased less demand and confidence in the treasury market) which are offering long-term yields of between 4.5% (10 year) and 4.9% (30 year). And for US high yield, income return has been close to 7%.²

The extra yield on offer, compared to recent history, presents attractive carry and income levels while still contributing to a lower average level of duration risk, than that of a pure government bond allocation. This higher income (in equities too) bolsters the diversification benefits of multi-asset portfolios, and that carry can provide a cushion against more adverse market conditions. 

Tactical manoeuvring

Inflation, interest rates as well as the broader macroeconomic and geopolitical backdrop are the primary drivers of fixed income markets. Bond positioning, especially in a multi-asset portfolio, needs to be dynamic and reactive. For example, in interest rate cutting cycles we may favour duration, as yields are going to be lower, while during periods of equity stress we can look to credit and investment grade – which can act as a stabiliser and help performance via carry and duration

During more risk-off periods, we look for duration hedge, and when we are more bullish, we opt for more high yield exposure, but it all depends on the macroeconomic and market environment. We can also look to inflation linked bonds to hedge against rising consumer prices.

Favoured plays

Within credit markets there has been a marked improvement in terms of ratings in recent years. Default rates are low - the US high yield bond default rate fell to a three-year low of 1.5% by the end of 2024³  – while the quality of companies and company balance sheets are stronger, and demand has been outweighing supply.

Presently we favour Europe over the US, in terms of duration. Fundamentally, Europe has been in a more complicated spot versus the US, which has enjoyed much stronger economic growth. Even though fiscal stimulus announcements have driven bond yields higher in anticipation of a forthcoming growth rebound, Europe still requires European Central Bank support. Moreover, Eurozone inflation is now near to its 2% target, which provides more room for rate cuts compared to the US, where inflation has been trending higher since last summer.

In addition, recent market events, especially on the tariff front, have increased inflation worries in the US. Unanchored inflation expectations are broadening, and this could drive rates much higher. Eventually, the ‘on and off’ on tariffs could start to erode foreign confidence and demand for Treasuries. All these elements could justify an increase of the term premium in the US fixed income market.   

Risks ahead

Credit has performed well but herein lies one of the main risks right now. If we see lower GDP growth and weaknesses in labour markets, economies and equity markets would be impacted, meaning in turn that credit spreads could widen considerably. However, income levels are good, so even in such a scenario they could potentially shield investors from the worst of any volatility.

Overall, despite the recent upheaval, fixed income liquidity remains solid, demand remains high, and defaults are rare. However, the US government’s unexpectedly aggressive stance on tariffs - along with threats of more action should trade partners retaliate further - introduces a significant headwind in the near term.

Market sentiment has turned increasingly risk-averse, and we anticipate a period of negative momentum over the next three to six months. The trajectory will depend heavily on how various countries respond, as prolonged tariff imposition could further weigh on growth and heighten inflation risks.

Strategic flexibility will be crucial in managing the current volatility and identifying potential opportunities in the months ahead.

But despite the uncertainty we believe there are plenty of fixed income opportunities. Despite expected further policy easing, interest rates should remain above inflation rates while relatively higher yields are creating more opportunities.