This is a sponsored article from J.P. Morgan Asset Management.

By Jonathan Liang, CFA, head of fixed income investment specialists for Asia ex-Japan

From rhetoric to reality

As the dust settles on a consequential election year, fixed income investors face the challenge of sifting through credible policy promises amidst the bluster of political rhetoric.

In the US, potential deregulation and tax cuts could support business sentiment and boost growth. However, tighter controls on immigration, punitive tariffs and sizeable fiscal expansion at a time of full employment could push inflation higher. The scale of the economic impact will depend on the size, scope and sequencing of the actual policies. If history is a guide, the bark is often worse than the bite, given the checks and balances of the legislative body and other legal mechanisms. Indeed, the magnitude of actual policies could differ materially from the sweeping scale of campaign promises.

To this end, elevated political and policy uncertainty could keep the interest rate markets volatile as market participants continue to divine the outlook for inflation, growth and monetary policy on the back of a potentially busy and dynamic government agenda. 2025 may yet prove to be the year when the political rubber meets the road.

Shallow easing

As it stands, the US economic outlook appears benign. Growth remains solid as corporates and consumers have proven resilient to higher interest rates. Inflation has receded meaningfully, making progress towards the Federal Reserve’s (Fed) 2% target. While the labour market has shown some signs of softening, wage growth remains robust and labour market conditions are generally tight. This, alongside the wealth effect from rising markets, has broadly supported consumption, a key engine of the US economy.

Looking forward, with inflation generally benign, the path to further rate cuts will likely depend on developments in the labour market. Further weakness could trigger the US central bank to adjust rates lower. Otherwise, the Fed will likely proceed cautiously as it awaits further clarity on the incoming Trump administration’s policies, which, on net, appear modestly hawkish for growth and inflation. Barring any significantly adverse labour market outcomes, the current easing cycle could prove to be a relatively shallow one.

Nevertheless, the bar for raising rates is high, and we believe the Fed could retain a cautiously dovish posture, choosing between slowing the pace of rate cuts or keeping policy settings unchanged. Against the backdrop of a resilient US economy, this still provides a constructive setup for fixed income, in particular, credit.

Bonds in the time of higher rates

As fixed income markets settle into a higher rate paradigm, the asset class is fulfilling its primary role of generating income. As illustrated below, looking across core and extended bond sectors, yields remain attractive, hovering well above the median of the last decade and, in some sectors, trading at the upper end of historical ranges. Furthermore, higher starting yields tend to correlate with higher forward returns¹. As cash rates decline, we believe this presents an attractive opportunity to lock in elevated yields.

The abundance of yield also creates a distinct opportunity for active fixed income managers without benchmark constraints to source high conviction ideas for income wherever they may be while managing risk by diversifying across multiple bond sectors. This approach can enhance income and total return within a diversified portfolio.

Yields across core and extended fixed income sectors remain attractive in a higher rate environment

Source: Bloomberg, FactSet, J.P. Morgan Credit Research, J.P. Morgan Asset Management. Data as of 31.12.2024. US Treasuries: Bloomberg US Treasury Index; US IG: Bloomberg US Corporate Index; US MBS: Bloomberg US Mortgage-Backed Securities (MBS) Index; US CMBS: Bloomberg US Investment Grade Commercial Mortgage-Backed Securities (CMBS); US ABS: Bloomberg Asset-Backed Securities (ABS) Index; Europe IG: Bloomberg Euro Aggregate Corporate Bond Index; USD EMD: J.P. Morgan Emerging Market Bond Index (EMBI) Global Diversified Index; Local Emerging Market Debt (EMD): J.P. Morgan GBI-EM Global Diversified Index; EM Corporates (Corp): J.P. Morgan Corporate Emerging Market Bond Index (CEMBI) Broad Diversified Index. Europe HY: Bloomberg Pan European High Yield (HY) Index; US HY: Bloomberg US Corporate High Yield Bond Index. All sectors shown are yield-to-worst. Yield-to-worst is the lowest possible yield that can be received on a bond apart from the company defaulting. Past performance is not indicative of current or future results.

Among our high conviction sectors are:

• Corporate credit. While credit spreads are at the narrower end of historical ranges, the outlook for revenue and earnings remains healthy, in our view. Bottom-up security selection and active management will be crucial to navigating potential bouts of volatility in rates and credit spreads. Within investment grade, we are positive on banks and specific energy sub-sectors and continue to find attractive opportunities in selective high yield² corporate credit.

• Securitised³ credit. This sector, which includes agency mortgage-backed securities³ (Agency MBS) and commercial mortgage-backed securities³ (CMBS), has remained a stalwart in our fixed income portfolios, not least because it presents attractive income opportunities that are uncorrelated to other sectors, such as corporate credit, hence providing diversification benefits in addition to income. The sector is buttressed by a relatively healthy US consumer, who continues to benefit from a tight labour market and solid real wage growth. Meanwhile, sub-sectors like residential rental real estate debt continue to be supported by a structural housing shortage, which has buoyed rental demand for single and multi-family residences, hence keeping rental income relatively resilient.

Taking a more nuanced view on duration

We are tactically cautious on duration⁴ due to lingering uncertainty in the policy outlook and elevated volatility in the rates market. If future policy actions lead to a resurgence of inflationary pressures, Treasuries could exacerbate portfolio volatility as the Fed adopts a more hawkish posture. Conversely, in the event of an economic downturn, Treasuries can act as a ballast for portfolios during a flight to safety. As it stands, the overall direction of the Trump administration’s policy agenda appears more inflationary than not. As such, we are generally short duration⁴ but may increase exposure if economic data indicates significant deterioration. In this uncertain economic environment, actively managing duration positioning across the yield curve will be crucial to mitigate volatility.

No longer a supporting character in portfolios

The days of the zero lower bound and negative yields have become a distant memory, allowing bonds to once again regain their rightful place in portfolios as both an attractive source of income and portfolio diversifier. While the fixed income market is rich with opportunities, policy uncertainty and elevated volatility underscore the importance of active management to navigate this fast-moving market. Bottom-up sector and security selection will be important to seek quality opportunities that can withstand the vagaries of the economic cycle.

At J.P. Morgan Asset Management, we strive to construct stronger bond portfolios with robust risk management⁵. We manage over US$3.3 trillion in assets, with over US$860 billion in fixed income⁶. Our fixed income solutions span the risk spectrum and are underpinned by the deep resources and rigorous research of a truly global platform.

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This is a sponsored article from J.P. Morgan Asset Management.