Continued volatility, falling yields, and other expectations for the year ahead, plus seven strategies to take advantage.
Having tamed runaway inflation, most central banks are now aligned in cutting rates. But as we saw in 2024, that doesn’t mean smooth sailing. This is a time of acute geopolitical uncertainty, from conflicts in the Middle East and Ukraine to the impact of 2024’s elections during a “Super Election Year” when 72 countries went to the polls.
In particular, President-elect Trump and a Republican Congress may enact policy changes that could reshape the world. Conjecture around these policies has contributed to elevated volatility across the capital markets.
Given likely policy changes in 2025, the regional mix of economic outcomes may change too. Overall, however, the trajectory for growth and bond yields remains slower and lower, in our view. Below, we share our expectations for 2025, as well as seven strategies for capitalizing on today’s favorable environment for bond investors.
Growth: Anticipating the Known Unknowns
We expect global growth to fall short of consensus expectations in 2025. Diverging growth will likely drive how much further interest rates fall in each region, with yields potentially falling more in Europe, for example, than in the US.
European economies, struggling to return to meaningful growth post-pandemic, are most vulnerable to an external shock that could push the region into recession. Existing challenges—both structural and geopolitical—could be exacerbated by new uncertainties, such as snap elections in Germany and the policies of the incoming US administration. We think these challenges could result in slower growth, deeper rate cuts and further yield declines than the market currently expects.
Meanwhile, we think that President-elect Trump’s policies may result in higher US nominal growth and inflation, and fewer cuts than previously expected by the US Federal Reserve. In fact, in the weeks surrounding the US election, US bond yields climbed sharply, reflecting speculation that Trump’s policies could lead to higher inflation and a widening federal deficit.
In China, policymakers have taken meaningful steps to support the economy, including rate cuts and a recent 10 trillion yuan ($1.4 trillion) debt package, but we view these as designed to manage the pace of the slowdown, not to push growth into a faster trajectory. China is also vulnerable to a trade conflict with the US.
Until we have clarity on the tariffs, taxes and other policies of the Trump administration, speculation and rate volatility are likely to persist. In our view, investors should get comfortable with evolving policy expectations and data surprises and avoid getting swept up in short-term turbulence. Broader trends, such as moderate global economic growth and high yields, matter more.
Yields: Going with the Flow
Predicting the direction of bond yields over the near term is challenging. Our focus remains on the intermediate term, and we think that’s where investors should focus too. Historically, yields have declined as central banks have eased. Thus, in our view, bonds are likely to enjoy a price boost as yields trend lower in the coming two to three years in most regions.
Demand for bonds could be exceptionally strong given how much money remains on the sidelines seeking an entry point. As of October 31, a record $6.9 trillion was sitting in US money-market funds, a relic of the “T-bill and chill” strategy popular when central banks were aggressively hiking interest rates. Now that central banks are easing and money-market rates are declining, we anticipate roughly $2.5 to $3 trillion will return to the bond market over the next few years.
Yield Curves: Under the Influence
The yield curve is a snapshot of investors’ current expectations for future economic conditions. Thus, the influences on the short end of the curve differ from those on the long end.
Central bank policy steers the short end of the curve, so investors focus on the latest jobs and inflation data. In the intermediate range—between two and 10 years—economic growth is key. For the longest maturities, long-term inflation and fiscal strength matter. Today, speculation is particularly high around long-term yields, thanks to growing national debts worldwide.
As a result, yield curves have already begun to steepen. We see room for further steepening as central banks continue to ease and bigger term premiums get priced into longer-dated yields due to concerns about national debt levels.
In the US, we expect the slope between five-year and 30-year bonds to increase most. Historically, when the Fed eased, this part of the curve steepened significantly, driven partly by recessionary environments. This time around, this slope has steepened but is still below historical averages (Display). In Europe, the slope between two-year and 10-year bonds may steepen most.
