The fixed-income outlook is delicately poised, with considerable uncertainty surrounding the Trump administration’s policy agenda and its impact on growth, inflation, central bank actions, government borrowing and geopolitical risk – all key concerns for bond managers.
So far, the administration has focused on the more growth-negative aspects of its agenda, particularly trade and immigration. Its priority has been to secure more balanced bilateral trade relationships while encouraging the reshoring of manufacturing to the US.
In the near term, however, these policies amount to a supply-side shock for the US economy, increasing the cost of doing business and pushing up consumer prices. This presents a dilemma for the Federal Reserve (Fed), which must weigh the prospects of weaker growth against a significant upward shift in the price level this year.
A key issue for the Fed is the potential for second-round effects, where tariff-driven price increases lead to broader inflationary pressures by 2026. While this is a risk, it appears more likely that slowing growth and softening labour markets will exert a disinflationary force.
The Fed is likely to prioritise employment over inflation if it must choose between its dual mandates
In any case, and in line with its approach since the global financial crisis, the Fed is likely to prioritise employment over inflation if it must choose between its dual mandates. This implies that rate cuts could be on the horizon, even if inflation remains above the Fed’s 2% target. Several reductions in US interest rates over the next 12 months now appear likely.
However, optimism about how far long-term US bond yields can fall should be tempered by Trump’s fiscal plans. Extending the Tax Cuts and Jobs Act and introducing further reductions could push US government borrowing to 140% of GDP within a decade.
This prospect poses challenges for long-dated US Treasuries. There is a real possibility that the Fed may again have to expand its balance sheet, this time to accommodate Trump’s fiscal expansion.
Subdued growth in 2024 and a slightly softer inflation outlook in 2025 support the case for short- and intermediate-term Gilts
For UK Gilt investors, this potential strain on long-dated Treasuries is significant. US ten- and 30-year bonds heavily influence global government bond pricing. Still, from a UK domestic perspective, subdued growth in 2024 and a slightly softer inflation outlook in 2025 support the case for short- and intermediate-term Gilts at current valuations.
Put simply, a neutral Base Rate in the UK is around 2.75%, while markets are currently pricing in a 3.5% rate – a restrictive stance that suggests a shallower easing cycle than is likely. That makes current short-dated Gilt yields look attractive.
However, the majority of the Gilt market consists of bonds with maturities beyond 15 years. In this long-dated segment, the influence of US Treasuries intersects with concerns over UK fiscal policy.
With long-term yields recently reaching their highest level in 27 years, there are emerging opportunities in the 15-year-plus sector
The UK’s Autumn Statement introduced a need for an additional £30bn of Gilt issuance per year, leaving the Chancellor with minimal fiscal headroom. Gross Gilt supply is now expected to surpass £300bn annually. Regardless of whether fiscal rules are met, these figures are daunting and have led to higher term premia – the additional yield investors demand for holding longer-dated bonds over shorter ones.
Nevertheless, with long-term yields recently reaching their highest level in 27 years, there are emerging opportunities in the 15-year-plus sector. One way to assess this is through the break-even rate between ten- and 20-year Gilts. This reflects the market’s expectation for the ten-year yield a decade from now, which currently stands at around 6.25% – an attractive level in the context of long-term investing.
As short-term Gilt yields begin to fall, the case for increasing exposure to longer-dated Gilts will grow stronger. For fixed-income investors with a long horizon, this may represent a valuable entry point.
Jon Cunliffe is head of investment office at JM Finn
