From Robert Tipp, chief investment strategist and head of global bonds, PGIM Fixed Income
Lacklustre Q4 performance sets the stage for a 2025 bull market
No doubt, the fourth quarter of 2024 was a mediocre one for bonds, aside from China. While some headlines relayed despair, we would argue that a very different storyline is playing out.
Overall the fixed income story since late 2022 is one of bonds posting respectable returns owing to factors that largely remain in place – moderating economic fundamentals will likely allow most central banks to lower rates further; and as investors endeavour to stay ahead of central bank rate cuts, their demand for yield and to lock in an income stream for the long run will likely prevent yields from moving into a new, higher range.
As a result, bond yields are likely to mirror the trend in Western central bank administered rates: stable or, more likely, falling as investors keep buying bonds, keen to stay ahead of central banks and lock in a long-term income stream.
The Q4 performance lull in the bond market has, in our estimation, set the stage bull market to resume in 2025, subject to short-term volatility owing to variability in the geopolitical, economic, and policy environment.
Also read: High Yield Credit: Maximising Exposure to the Higher Rates Environment
Still Early Stages for the Shift into Bonds
Although investor positioning is difficult to divine, there are at least some signs that cash balances remain elevated and/or rising. As one key indication, money fund balances are extremely high relative to the level of GDP and in absolute terms.
US money fund balances rose by more than USD 300 billion in Q4 2024 – historic highs on an absolute basis and relative to GDP, suggesting investors remain defensive.
This cash may represent latent demand that could shift to bonds if and as central banks continue cutting rates.
An Extended Window for Narrow Spreads
While today’s historically tight credit spreads and the experience over the past 20 years point to caution when it comes to credit exposure, this may not be the right approach in the current environment.
Instead, given the prospects for continued moderate economic growth, generally benign credit fundamentals, and strong demand for fixed income, we think an extended period of narrow spreads is a more likely outcome.
This could manifest as a slightly more volatile version of the 1992-1997 or 2004-2007 periods, in which case credit products may continue delivering positive excess returns.
What About the Risks?
Geopolitical risks and policy dynamics – in particular trade frictions – could lead to periodic volatility as 2025 progresses.
However, since late 2022, the bull market has weathered a series of economic, policy, and geopolitical threats. Looking ahead, we will keep an open mind and will expect more of the same: quarter-to-quarter volatility within the context of a bull market (literally) carrying on.
