We see upside risk to US yields over the next 12 months from inflationary risks and concerns over looser fiscal policy under the Trump administration. Nevertheless, opportunities can still be found in bond markets in the front- and intermediate maturities which are the sweet spots.

Vasu Menon
Managing Director
Global Wealth Management
OCBC Bank

We see near-term challenges to fixed income. Over the next few months, tariffs and its economic impact remain a key risk, which could influence the Federal Reserve’s (Fed) decisions. Still, opportunities can be found in the fixed income space, and investors should have some representation of bonds in their portfolios.

Fixed income strategy

We see opportunities in the bond markets in the front- and intermediate maturities and see them offering the best protection from rates volatility. However, we are cautious of duration risk, anticipating higher yields over the next 12 months, particularly along the long end.

Rates and US Treasuries

The downside surprise on December’s core inflation data in the US provided relief on inflationary concerns, which triggered a massive rally in 10-year US Treasury (UST) yields. After peaking at 4.80% in mid-January, 10-year UST yields have rallied to about 4.50% (at the time of writing) even as Fed officials remained cautious on the path ahead.

At the January Federal Open Market Committee (FOMC) meeting, the Committee kept the fed funds rates unchanged at 4.25-4.50% after delivering 100 basis points of rate cuts over the previous three meetings. There appears to be a consensus that rates should remain on hold for now. The FOMC meeting statement was hawkish, removing references to the past cooling in inflation and labour markets. Powell downplayed the likelihood of a rate cut at the upcoming March meeting, pointing to uncertainty around tariffs, immigration and fiscal policy, while saying the Fed must “wait and see”. Our house view remains that the Fed may be able to deliver another rate cut this year, although the likelihood is diminishing due to tariffs threats.

Tariffs will hurt growth, driving down yields on long-end UST yields in the near term. However, we anticipate a potential offsetting factor. The US fiscal trajectory remains uncertain given the likely extension of tax cuts in 2026. The impact of fiscal stimulus is likely to boost growth and further re-ignite inflation. In addition, high government deficits could mean greater UST supply next year, driving yields higher along the long end of the curve.

Reflecting these expectations, we hold a cautious view on USTs.

Developed Markets

Credit spreads for Developed Markets bonds have been resilient despite an initial surge in UST yields and the volatility caused by the initial rollout of executive orders and announcements in President Trump’s new administration. IG spreads remain unchanged while HY spreads have tightened.

Presently, the prospects of deregulation, tax cuts and expectations for a business-friendly environment drive market optimism. However, with announcements of a flat 25% tariffs on Canada and Mexico (although paused at the time of writing), and 10% on China - volatility is expected to pick up, as all three countries are likely to impose some level of retaliation. With credit spreads hovering at decades tight, spreads are not sufficiently pricing in the potential economic and financial impact.

Over the next 12 months, we see reasons for caution. Although the carry from elevated yields is attractive, credit spreads are at risk of widening amidst growth concerns from the impact of tariffs. In addition, our view on higher rates further shaves off the return from carry. Overall, we prefer assuming credit risk along the front-end versus the longer-duration alternatives.

Emerging Markets

With a wide range of variables and uncertainties into 2025, we remain Neutral on Emerging Markets (EM) credits. A stronger US Dollar and tariffs should translate into wider EM spreads over the next 12 months, but strong technical factors are important offsetting considerations.

Asia

Unlike Mexico and Canada where Trump’s 25% tariffs have been pushed out by a month, the additional 10% tariffs on China have kicked in as of 4th February. So far, China’s retaliatory measures to the additional tariffs have been relatively more targeted, suggesting efforts to keep the doors to negotiations open before the counter measures kick in on 10 February. This opens the risk a further response from Trump to China’s retaliation. Given that the comprehensive trade policy review is expected to be completed by 1 April, the ultimate timing and magnitude of additional US tariffs on China remains uncertain. Significantly high tariffs could have an adverse impact on China’s growth, and we expect China to roll out more domestic policy support in the event of major external shocks. For now, we prefer to be more defensively positioned in higher quality corporates and/or financials with strong government support.

Against the backdrop of uncertain rates and potentially slower growth within Asia, we expect financials and domestically focused corporates with hedged currency exposure to navigate headwinds better than corporates with high exposure to the US market, or those with large unhedged currency exposures. We remain constructive on Indian credits, although we are less bullish on the renewable energy sector due to valuations and increased idiosyncratic risks.