Transcript: For fixed-income investors, 2025 will be all about coupon clipping
Siena Sheldon of Brandywine Global Investment Management says active duration management will be key to bond success
- January 14, 2025 January 9, 2025
- 13:01
iStockphoto/DKosig
Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking about the outlook for fixed-income investing in 2025 with Siena Sheldon, vice president, client portfolio manager, with Brandywine Global Investment Management. We asked about interest rates, yields, and where she sees opportunities. And we started by asking her to describe the current environment for fixed-income investing.
Siena Sheldon (SS): The environment in 2024 generally provided support for bond holders, and this was driven largely by higher yields that cushioned investors from interest-rate volatility that we did see throughout the year. But, overall, major central banks embarked on rate-cutting cycles, and bondholders did generate good returns within fixed income, specifically in credit markets. This year, return opportunities will be more idiosyncratic in the government-bond landscape. So active duration management will be key. This year is also going to be another year that is all about yields, because there are still some great income opportunities out there. So, in other words, this is another great year to clip coupon.
Where interest rates are headed
SS: We believe the Bank of Canada will continue to be more dovish than the Fed. That said, we do believe they will proceed at a more gradual pace of 25 basis points, as they have already indicated. The outlook for the Fed’s rate-cutting cycle has grown more cautious. And that’s because you still have relative growth outperformance in the U.S. You also now have policy uncertainty under the incoming Trump administration. All of this means terminal rates are likely now higher in the U.S. So likely, in the U.S., rates will move lower, but at a slower pace than previously expected. In other developed markets, like Europe, falling inflation and weaker growth are likely to result in more rate cuts. In emerging markets, some continue to offer attractive yield. Last year, hard currency, corporate and sovereign markets did outperform. Depending on domestic policy of the country and the performance of the dollar, you could see some local markets outperform next year.
Where she sees opportunities
SS: Within fixed-income sectors, we currently prefer shorter-dated, high-yield corporate credits. You have a strong growth backdrop that is likely further supported by the incoming Trump administration. You also have strong fundamentals in the high-yield market, as well as great yields and prices in the 90s. So shorter-dated high yield is a great place to be. We also like other spread sectors such as MBS, specifically U.S. housing exposure, both agency and some non-agency. The U.S. housing market is sound heading into this year.
On bond valuations
SS: We do like high-yield corporate credits, but it’s no secret that spreads are tight, and that’s a risk that must be managed. So, it’s important to be selective in credits in the months ahead, given where valuations are but with a high yield and dollar priced below par, these are still attractive. Defaults are low, and the high-yield market is much less exposed to interest-rate risk. And equity markets continue to peak at all-time highs. So, if you’re overexposed to stocks, it might make sense to shift into fixed income that is giving you some coupon like high-yield corporate credit. And while it’s true spreads are near the tights of 2007, it’s important to remember that this is a very different high-yield market versus 2007. The duration of the high-yield index is lower now than in 2007. You have less interest-rate risk. Prices in 2007 were just above par, whereas prices now are trading below par. And then, in 2007, you had high-leverage ratios and loose lending standards, and now, because the private credit market has taken a lot of those lower-quality loans, you have a higher-quality high-yield market today than in 2007. So, although spreads are tight, fundamentals and continued demand mean it’s still a great asset class to be in.
And finally, what’s the bottom line for fixed-income investing in 2025?
SS: This year will be a story that is largely about clipping coupon. Yields are still high. So, it is still very much about income in this environment. With the U.S. economy in a pretty solid space, shorter-dated corporate credits, especially within high yield, are a great place to be. There will be more monetary policy divergence in 2025 on the government-bond side but this creates more idiosyncratic alpha opportunities in fixed income. So, in this environment, it’s really important to have an active duration manager that can tease out where inflation is falling, where does the policy landscape and real-world yields look favourable, so that you can create those alpha opportunities.
Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to Siena Sheldon of Brandywine Global Investment Management. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.
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