This year has seen huge shifts in the macroeconomic and geopolitical landscape. Principles such as free trade, globalisation and central bank independence that have underpinned the global economy for decades are being challenged. Despite this, credit spreads are at all-time tight levels and equity markets at historic highs.
What are fixed income investors to make of the current environment and how should they best position portfolios to capture results?
At Capital Group’s latest biannual Portfolio Strategy Group (PSG) forum, we attempted to make sense of the noise and identify the key themes we think will drive markets.
Amid the shifting landscape, we think a key trend we identified back in the spring, namely a cyclical convergence of growth between the US and the rest of the world, is likely to continue. At a secular level, however, the picture is less clear with the US caught between AI and fiscal stimulus on the one hand, and a deterioration of institutional trust on the other.
The US’s implementation of tariffs and re-ordering of global trade continues to reverberate through the global economy. Although their full effect has yet to be felt, we think the stagflationary impact of tariffs on the US will continue as companies adjust to the more restrictive trade environment. Our expectation is that this has an impact on consumer and investment activity and leads to a moderation of US economic growth, but a recession is unlikely, with fiscal stimulus and Federal Reserve policy helping to offset trade headwinds.
In contrast, Europe has better cyclical growth potential, largely as a result of Germany’s proposed fiscal spending plans. This increase in spending, which comes against a backdrop of broader economic resilience in the eurozone, could add to inflationary pressures in the region and mean the European Central Bank hikes rates next year.
Taken together, this suggests global growth will moderate but remain positive in 2026 and could potentially reaccelerate in the second half of the year.
Over the past 12 months, periods of market stress have seen fixed income markets provide the diversification expected of the asset class. This is largely due to duration, which has rallied in anticipation of central bank easing. That said, divergent monetary policy cycles and long-term policy risk in the US mean a more nuanced approach is appropriate, using relative value positioning to capture the opportunity rather than a traditional allocation to US Treasuries to provide diversification.
This remains a pivotal time for the global economy, with many certainties of the past 40 years or more seeming to be in flux. The possible convergence of economic growth and divergence of policy between the US and Europe provide some potentially exciting investment opportunities. However, given the ongoing uncertainty and tightness of valuations, active management remains crucial, and we continue to position fixed income portfolios defensively, focusing on idiosyncratic opportunities while closely watching developments.
