CONTRIBUTORS
Sonal Desai, Ph.D.
Chief Investment Officer,
Portfolio Manager
Mike Salm
Director of Multi-Sector Strategy
Patrick Klein, Ph.D.
Director of Multi-Sector Strategy,
Portfolio Manager
United States
Albert Chan, CFA
Head of Portfolio Construction & Analytics
Executive summary
We believe the US economy remains strong, with gross domestic product (GDP) growth above trend despite recent pullbacks in retail sales and consumer confidence. Concerns over US President Donald Trump's tariff policies may be overstated, but persistent fiscal deficits will likely have a longer-term impact. The EU’s economy is weaker, with anemic growth, which has led the European Central Bank (ECB) to cut rates. Trump’s trade policy has created market uncertainty, potentially delaying disinflation and impacting economic growth. Market expectations of the Fed's rate-cut path have fluctuated, reflecting concerns over economic policies. Fixed income spreads have widened again in 2025, due to uncertainty around tariff and fiscal policies. Our portfolio strategy focuses on balancing duration,1 diversification and adjusting international exposures to mitigate risks.
Second quarter 2025 portfolio themes
- Duration balancing: In the past several sector views publications, we had advocated for remaining on the shorter end of the yield curve to limit the impact of rising yields across maturities. This view has not changed. In our view, UST yields remain below our base-case projection of fair value. Given the current state of the markets and heightened levels of uncertainty, we still feel that the Fed has limited room to maneuver and has one to two cuts left in this series before reaching a steady state of around 4%. We continue to adjust our duration positioning to take advantage of changing yields in the market.
- Diversification: We believe it is prudent to spread exposure across a number of fixed income sectors. Given the uncertain times that we are in, we think it is even more important. In any scenario of tariffs and fiscal spending increases, there will be winners and losers. Within our portfolio construction and optimization process, we not only look at the correlations of sectors against themselves but also use duration exposures to hedge out macroeconomic risks such as a slowing economy or an increase in inflation. Diversified positioning can provide a substantial base to use risk mitigation tools to improve outcomes.
- International impacts: With a broadly closed US economy, we feel that the impact of increased tariffs will have a limited impact on growth and inflation. That might not be the case for many of our trading partners. Economies in Canada, Mexico and the EU have more skin in the tariff game, which gives them less leverage to negotiate a beneficial outcome. Emerging market economies may have even higher exposure to US trade policy. We are adjusting our country and currency exposures to take into account various US tariff changes and reciprocal trade levies and their impact on fixed income returns.
Overall risk outlook
We have left our overall risk outlook at neutral, as we see strong economic fundamentals being offset by increased uncertainty regarding Trump’s economic policies. The on-again, off-again tariff news has caused some trepidation within the market, since no one has much insight into the endgame. Trump himself as stated that the US economy would feel some pain as it adjusts to the new reality. With this backdrop, we have seen spreads across most fixed income sectors widened from what had been 20-year lows. Technical conditions continue to be strong across sectors, but we feel this could change relatively quickly if volatility remains high. Changes to US tariffs will have a stronger effect on internationally focused sectors including European credit and emerging market debt. In our view, spreads have not widened enough, on the whole, to warrant us changing our neutral stance. We have been using volatility in relative spreads to rebalance our holdings, taking advantage of sectoral spread moves.
Endnote
- Duration measures the sensitivity of price (the value of principal) of a fixed-income investment to a change in interest rates. The higher the duration number, the more sensitive a fixed-income investment will be to interest rate changes.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default. Floating-rate loans and debt securities are typically rated below investment grade and are subject to greater risk of default, which could result in a loss of principal. Asset-backed, mortgage-backed or mortgage-related securities are subject to prepayment and extension risks. International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Leverage increases the volatility of investment returns and subjects investments to magnified losses and a decline in value.
Diversification does not guarantee a profit or protect against a loss.