Schroders global investment analyzes the prospects for bonds, credit, and emerging market debt in 2025 with Julien Houdain, global unconstrained fixed income head, Lisa Hornby, US fixed income head, and Abdallah Guezour, head of emerging market bonds and commodities. Schroders global investment predicts that the credit fundamentals in 2025 will remain strong. In addition to higher total returns and a steeper yield curve, which should continue to attract funds into the credit market. Credit valuations may be supported, but the room for further compression is limited. Among industry sectors, the banking sector is favored. As we enter 2025, although the years change, the drivers behind the market will remain the same. The evolution of economic fundamentals and policy changes will continue to be key factors. The upcoming reforms by the new US government will have a profound impact on the market, but it is also worth paying attention to the fiscal policy plans of Europe, the UK, and China, which will play important roles in shaping the overall economic cycle and central bank strategies in each country. These factors may create a favorable environment for the fixed income market, as these assets will benefit from broader economic trends and a higher starting point for yields. The position of fixed income in investment portfolios is not only due to its attractive income potential but also because of its capital appreciation potential. Compared to more cyclical asset categories in the market, fixed income can play a role in diversifying risk. In 2024, the US economy had strong growth, inflation improved, and the labor market approached balance before the presidential election. The economy achieved equilibrium and the much-discussed concept of a "soft landing" - where economic growth slows but does not enter a recession, while inflation pressures ease - was coming to fruition. The key question for 2025 is whether this momentum can continue. As 2025 approaches, policy uncertainty remains high. Key issues on the US political agenda, including stricter immigration control, looser fiscal policy, reduced regulation of businesses, and tariffs on international goods, all point to increasing risks. These factors may hinder the improvement of core inflation and could lead the Federal Reserve to halt its loose monetary policy earlier than expected. In other words, the risk of an economic "hard landing" is increasing, where inflation remains high, and interest rates may need to remain high for longer than anticipated, although this is not the baseline prediction. Schroders global investment mentions that the potential impact of the Trump administration on economic growth is unclear. Firstly, as mentioned earlier, current US economic growth is already quite strong. Although there is still potential for further improvement, it is important to note that the current economic base is already relatively high. Measures such as reducing regulation and strengthening fiscal impact may promote growth. These measures include wiser investments in key areas such as infrastructure, education, and healthcare to stimulate economic growth, create employment opportunities, and ensure that public funds benefit citizens the most. However, if stricter immigration policies lead to labor shortages or higher tariffs disrupt global trade significantly, this could have a negative impact on growth. The pace, scale, and order of implementation of these different policies will play a key role in guiding market direction. While the potential growth and inflation drivers of US government policy have increased expectations for the risk of an economic "hard landing," the improvement in bond valuations provides a stronger buffer for these risks. At the beginning of the new year, the nominal yield of US 10-year government bonds may exceed 4%, while the real yield (adjusted for inflation) could be higher than 2%, presenting an attractive yield level not seen since the 2008 global financial crisis. Additionally, with the decrease in policy rates, the negative carry (where the bond yield is lower than the cost of financing the bond position) that hindered holding bonds in recent years has disappeared, with only the shortest-term bonds still having this issue. With lower inflation levels, the diversification advantage of bonds will be strengthened, effectively hedging against the weakness of cyclical assets. Compared to alternative assets, bonds also appear cheaper, with current yield rates higher than the expected earnings yield of the S&P 500 index. With these changes, bonds can play a dual role in investment portfolios: providing income sources and strengthening the resilience of diversified portfolios. Adopt a cautious stance on credit while seeking value in securitized assets Schroders global investment states that reasonable valuations, strong growth, and central bank accommodative policies in 2024 provided a favorable market environment for cyclical assets (such as corporate bonds). Overall performance has been strong, especially in high-yield areas. In 2024, credit spreads gradually narrowed. In several market areas, including US investment-grade and high-yield corporate bonds, current spreads are approaching the lowest levels since the pandemic. This trend indicates that investors have gained confidence in the market and are more willing to invest in high-risk assets. Strong economic growth, robust demand for fixed income assets, and expectations that the macroeconomic environment will remain supportive collectively drove the narrowing of spreads. It is expected that the credit fundamentals in 2025 will remain strong. In addition to higher total returns and a steeper yield curve, which should continue to attract funds into the credit market. While credit valuations may be supported, the room for further compression is limited. In other words, although credit spreads may still be relatively expensive, there is limited room for them to become even more expensive. Therefore, a more cautious approach towards these assets is recommended within cross-sector investment portfolios, focusing on shorter-term corporate bonds, as they can provide good returns with limited duration risk (i.e., limited sensitivity to changes in credit spreads). Among industry sectors, the banking sector is favored due to its valuations compared to the industrial sector.Attractive, the capital situation in this industry remains stable, and a steeper yield curve should improve bank net interest margins. Securitized assets (such as Mortgage-Backed Securities, or MBS) can provide better investment opportunities. MBS are issued by government-sponsored enterprises and supported by a series of mortgage loans. Similar to investment-grade corporate bonds, these high-quality assets can still provide good cash flows, and valuations are at historically attractive levels. With the regulatory environment in the United States becoming more relaxed, and US banks able to include these securities in their asset portfolios, demand in this area is expected to increase.In addition, as the Federal Reserve lowers interest rates, it is expected that a portion of the record-breaking $7 trillion US currency market accounts will flow into the fixed income market. These types of assets have greater potential for capital appreciation and lower individual credit risk. Therefore, they remain preferred in asset allocation. Finally, it is advisable to incorporate a certain level of liquidity into the investment portfolio. With the valuation of most credit categories at historical lows and significant uncertainty in fiscal policy, market volatility is likely to provide opportunities to deploy investments at lower costs. Liquidity is being incorporated in various ways, such as through short-term, high-quality asset-backed securities, short-term corporate bonds, and US Treasury bonds. Emerging market bonds show relative resilience, with investor confidence continuing to strengthen Schroders Global Investment predicts that by 2024, emerging market debt (EMD) will demonstrate relative resilience amidst pressures such as rising yields on developed market government bonds, ongoing geopolitical uncertainties, and uncertainty surrounding the US presidential election. There is a significant divergence in performance between hard currency debt (debt denominated in widely stable currencies like the US dollar) and local currency debt (debt denominated in the issuing country's currency). Hard currency debt, including sovereign and corporate bonds, offer attractive total returns due to the high income generated by high-yield issuers. These issuers typically have lower credit ratings compared to investment-grade bonds, leading to higher default risk. In contrast, emerging market local currency bonds performed well in 2023, as currencies in various markets weakened and government bond yields experienced significant adjustments, especially in countries like Brazil and Mexico where fiscal issues impacted investor confidence. However, due to insufficient allocation by international investors in local debt markets, these concerns may be somewhat magnified and have been reflected in lower valuations of local government bonds. Investor confidence in emerging market bonds continues to strengthen Looking ahead to 2025, despite ongoing global uncertainties and specific challenges faced by some countries, the trend of narrowing spreads for emerging market sovereign and corporate bonds seems likely to continue. This suggests that the yield (or interest rate) differentials between these bonds and safe-haven investments (like developed market bonds) are shrinking, indicating increasing investor confidence in emerging market bonds. This optimism mainly stems from positive signs of growth in emerging markets and the solid financial positions of many emerging market issuers. Additionally, the increase in foreign exchange reserves in emerging markets highlights the positive impacts of recent macroeconomic adjustments. Although these improvements are reflected in current historically tight levels of spreads for investment-grade emerging market bonds, the high yield category still presents attractive value. Spreads for sovereign debt in countries like Argentina, Egypt, Nigeria, Ivory Coast, Senegal, Sri Lanka, and Pakistan remain attractive and have made good progress in macroeconomic adjustments following recent crises.