Art by Andrea D’Aquino
2025 could be an interesting year for fixed income. End-of–year performance across credit asset classes was broadly positive and many of the trends driving that performance appear likely to continue. However, 2024’s elections in the U.S. and the deterioration of governments in several EU member states could add to ongoing geopolitical uncertainty. That uncertainty could impact credit performance in a handful of major investment markets and is pushing some investors to look for diversification in global credit and private credit.
Sources say, with so many unknowns going into the beginning of 2025 it is hard to forecast how performance will ultimately shake out. Investors may choose to be a bit more tactical over the next six months in response to higher volatility and greater uncertainty.
The Good
According to a recent research note from Schroders, we’re likely to start 2025 “with 10-year U.S. Treasury nominal yields above 4%, and real yields (net of inflation) above 2%, an attractive level of income we haven’t seen since the 2008 financial crisis.” This will mitigate some of the negative carry that has made holding long-duration bonds more expensive in recent years.
The Federal Reserve also made good on its December quarter point cut, a move which markets wanted and had already priced in. The European Central Bank cut rates by 25 bps, also as expected. Alongside that cut, President Lagarde’s forward guidance was more hawkish than expected, driving an increase in medium-term yields.
These trends will likely be supportive for treasury portfolios going into the first quarter while markets figure out whether more rate cuts are on deck. Markets have signaled that they want more cuts but during his most recent remarks, Fed Chair Powell indicated he was fairly comfortable with where rates are now relative to economic and inflation data – a position which many interpreted as dovish on future cuts.
Even without additional cuts, bonds could be boosted by lower overall inflation. Schroders notes that “at lower inflation levels, the diversification benefit of bonds increases, providing a more efficient hedge against weakness in cyclical assets. Bonds also look cheap versus alternative assets, with current yields higher than that of the expected earnings yield on the S&P 500.”
Simon Dangoor, head of fixed income macro strategies at Goldman Sachs Asset Management, adds that 2025 is likely to be a good year for getting income from credit investments. “A big feature of 2024 is that spreads compressed to very tight levels which makes things look expensive at face value. That might lead some investors to say they want to take money off the table and head for the hills, but I think, in the U.S. in particular given the fundamental and technical aspects of the market right now, 2025 could still be a very good year for income.”
These trends extend into corporate credit and high-yield as well. Demand for income is high and issuers have remained very disciplined about supply, Dangoor, says. “We haven’t seen anything in the way of corporates trying to deteriorate their balance sheets and we expect the default rate to remain low throughout the next year. Both of these factors are positives for investors,” he says.
David Fann, senior managing director at VSS Capital Partners, agrees. He says that while some expected a wave of bankruptcies and restructurings to hit companies – especially those reliant on private credit financing – that wave has not materialized.
“We continue to see that banks and financial sponsors are comfortable with where the market is at and are willing to amend or extend maturities in many cases for companies that have strong balance sheets,” Fann says. “That’s been the story for a few years now and we don’t yet see data that might indicate distress or a willingness on the part of liquidity providers to start getting more restrictive.”
The Potentially Less Good
It can be tempting to look at these topline trends and think 2025 will be smooth sailing for credit investing, but heightened volatility is also likely to be a feature of the new year.
In the U.S., the incoming Trump administration has signaled its willingness to consider widespread tariffs as well as strict limitations on immigration – policy positions that are by their nature inflationary. How these policies eventually shake out is a source of great debate. Many sources CIO spoke to for this story argue that President Trump’s tariff positions are mostly noise designed to bring industries to the table and force negotiations. From a practical standpoint, if the administration does end up using tariffs, it will likely take several months to a year to implement.
Karin Anderson, director of credit manager research at WTW, says that with that kind of phased-in implementation, the Fed may opt to look past any initial market or supply reaction before changing course and potentially raising rates to head off inflation.
“It’s probably going to be better for everyone – investors included – that it will take some time to implement these policies, because I think it lessens the risk that the Fed would be pushed into raising rates again. That said, it really depends on how the policies are crafted if they move forward. There is inflationary risk and that could have an impact on rates,” she says.
Dangoor adds that Trump’s pick of Scott Bessent as his nominee for Treasury Secretary indicates sensitivity to bond market reaction, which could mean that the administration may be willing to back off the most destructive of its policy proposals if those policies risk the ire of bond markets. “This looks to be a relatively business friendly administration, so there could be a lot of nuance in how these policies unfold,” he says.
Outside the U.S., the deterioration of governmental coalitions in France and Germany could put pressure on European credit if uncertainty over those governments lingers. Still inflation is beginning to normalize throughout the continent which is positive for investors overall. Dangoor says that investors may find diversification in global credit opportunities if they are concerned about volatility in the U.S. market.
“You have to pick your spots,” he says. “But there are interesting themes in rates in countries where inflation is cooling and economic activity is still positive. Sweden is one, Canada is another. Inflation is starting to come down in Australia so that could be positive as well.”
When it comes to private credit, sources say investors are still upbeat. Private credit funds had another solid fundraising year and there is significant demand from businesses to put money to work. Lower interest rates raise questions about potential returns for these funds. Private credit loans are typically floating-rate and get a bit of a boost from higher interest rates. However, the slowdown in mergers and acquisitions, driven by higher capital costs, has meant ultimately that there are fewer deals to finance.
Fann says investors could start to see these dynamics shift if rates go lower. Private credit funds may have more deals to do if M&A returns, but itis likely they will get done at a lower return multiple.
Private credit funds have also been supported by the growth of net-asset-value-lending and continuation funds, as private equity managers look for ways to return capital back to investors in lieu of traditional exits. Those business lines are likely to continue to expand at least in the short-term until M&A activity resumes.
Investors are often wary of these tools, but Fann says, “We’re in a new normal. Capital costs are higher, M&A timelines are longer. I think you’re going to see these synthetic liquidity options continue to be used because they can solve some of the challenges brought on by the current market environment. I think you’re going to see the issues on investor alignment and valuations resolve themselves over time but it will take time to play out.”
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Tags: Bonds, David Fann, Goldman Sachs Asset Management, Interest Rates, Karin Anderson, Simon Dangoor, VSS Capital Partners, WTW