multi asset: how higher rates risk could improve diversification

yield uptrend eyes deficits.

The election of Donald Trump as the US president has acted as a catalyst in the bond markets. Since September, both inflation and real rates have progressively shown an uptrend in anticipation of another year of loose fiscal policies in the US and Europe. As debt levels rise, yields have remained high and have recently trended upwards, proving costly to fixed-income allocations after a very positive third quarter.

The re-election of Trump has reinforced rather than altered this scenario. His promise of corporate tax cuts is likely to deepen public deficits for a few more years. The situation echoes the Reagan era that followed a decade of high and sticky inflation in the 1970s, curbed by the Federal Reserve maintaining tight policy for an extended period.

rates risk in the driving seat.

Public deficits and fiscal dominance are likely to shape the risks and returns of 2025: it could be another year of continued market stress and dispersion in rate expectations. The creditworthiness of major states is expected to continue deteriorating as primary budget deficits meet higher borrowing costs. Meanwhile, from a more structural point of view, depleted savings and demographic shifts should also contribute to this imbalance.

Higher yields and lower credit quality are significant factors contributing to greater volatility in the bond market, meaning rates risk should remain higher than the past decade and more in line with 2023-24. However, once the US debt ceiling negotiations conclude and European public finances become clearer, we should find ourselves in a situation with higher, and therefore more attractive, G10 bond yields.

While rates uncertainty could remain high, a pronounced deterioration seems improbable due to its negative impact on risky assets and the economy, which tend to trigger central banks to react by cutting rates. Even though 2025 could be a year of high rate risks, there are methods to hedge or mitigate this risk while keeping rates exposure in our portfolios.

potential further down the road.

Eventually, increased risks today should lead to improved returns and augment diversification potential down the road: this is a key message for most USD-, GBP- and EUR-denominated institutional investors. Risk-focused solutions such as our All Roads strategies are likely to piggy-back on this fixed income opportunity as it begins to manifest in improved trends, risk measures, and macroeconomic data.

In a period of low earnings yield, the emergence of opportunity in fixed income could prove essential to the success of any diversified portfolio.

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author.

Aurèle Storno
CIO, Multi Asset

after the bell.

What’s your new year’s investment resolution?

My investment resolution for 2025 is to look for expertise outside the investment world and learn from it. What techniques are used in weather forecasting, earthquake risk monitoring or sailing strategies? What could they teach us to enhance our investment processes? Many fields outside finance similarly rely on techniques and disciplines to manage uncertainty. They can help us understand our own financial challenges through a different lens and bring innovation to our processes.

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For professional investors use only

This document is a Corporate Communication for Professional Investors only and is not a marketing communication related to a fund, an investment product or investment services in your country. This document is not intended to provide investment, tax, accounting, professional or legal advice.

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