Fixed Income: The Calm Before the Storm?

Fixed income markets have shown relative calm versus other risk assets since the start of the year. That is unlikely to last, creating challenges and opportunities.

Much of our focus recently has been on the market impact of geopolitical events, the threat of AI-related disruption and oscillating capex concerns, and the sector rotation reshaping equities.

Since the start of the year, these forces have driven short, sharp bouts of equity market turbulence, often followed quickly by emphatic recoveries. Volatility in commodities and precious metals has also been especially pronounced—if not outright wild in a few areas.

In contrast, global rates and credit markets have so far shown greater poise than their risk-asset cousins. Most developed-market government bond curves (outside Japan) have been broadly stable, and credit spreads continue to trade at or near historic tights.

In our view, there are good reasons for this—but we would caution against being lulled into complacency. Even as the macro backdrop appears constructive—with a monetary easing bias, disinflationary trends, and expectations for firmer growth—there are still clear vulnerabilities that could disrupt the calm.

The U.S. Supreme Court’s landmark ruling on Friday that the administration’s tariffs are illegal is one issue with some disruptive potential. Others include escalating tensions over Iran, the midterm elections in November, and the prospect of a new European Central Bank chair early next year. At the market level, the stresses emerging in the U.S. private credit market are also a growing concern.

Against this backdrop, fixed income security selection and global diversification matter more than usual—particularly as tail risk rises—a view we set out in our Fixed Income Investment Outlook at the end of last year.

A New Fed Chair and Divergent Macro Opportunities

Barring any seismic inflation shock, the most significant known event in global rates this year—certainly in the first half—is likely to be Kevin Warsh’s arrival as Federal Reserve chair in May.

While Warsh’s nomination still needs to be confirmed by the Senate Banking Committee and approved by a full Senate vote, we do not expect the process to be problematic. How, then, will Warsh lead the Fed?

Greater clarity will emerge over time, but it is widely expected that his leadership could bring a closer relationship between the Fed and the Treasury, a smaller Fed balance sheet, and potentially additional interest-rate cuts. In our view, those cuts would be supported by a continued downward trend in inflation and a labor market that still exhibits some degree of fragility.

For now, we maintain our view that long-term Treasury yields already reflect the key known risks and that, overall, the term premium has stabilized. This suggests that investors could benefit from extending duration this year to generate additional income, with relatively limited risk of a further sustained rise in long-bond yields.

That said, U.S. fiscal uncertainty and political volatility could further weaken the dollar, reinforcing the case for global diversification. With policy paths and inflation trends diverging, we see opportunities at the long end of European, U.K., and Japanese rates markets, as well as in emerging markets debt, supported by the yield advantage, favorable growth dynamics, and moderating inflation.

Moreover, emerging markets debt has tended to perform well during periods of U.S. monetary easing and dollar weakness—trends that currently persist and, in our view, appear unlikely to reverse in the near term.

AI-Related Public and Private Credit Risk

In corporate credit, it is difficult to identify a bigger risk today than AI-driven business-model disruption—alongside the strain of massive, AI capex-related debt issuance among U.S. hyperscalers.

Just as equity investors have been swiftly and, at times, brutally reassessing exposures to AI-vulnerable sectors and the major capex spenders—as we highlighted here recently in our piece Software Leads AI Tech Rout—What Next?—debt investors similarly need to sharpen their focus on selectivity and diversification.

Credit spreads for the hyperscalers have, for instance, broadly widened since the end of last year on their record capex-related issuance needs, with the spreads of triple-A rated Microsoft almost doubling (though they remain at sector lows) since the start of the year. What’s more, stress in private credit has also come into focus: the bonds (and shares) of business development companies, listed private credit funds, have taken a hit recently on concerns over the extent of their loans to the software and IT services sectors. The market was further spooked last week on news one fund had decided to block retail investor redemptions.

These dynamics only heighten the need to sharpen our focus on credit risk and be more selective—both within the hyperscalers, where we remain opportunistic buyers when valuations compensate for the risks, and across the industries most exposed to AI disruption. Under our own credit analysis, some of these industries include IT services, interactive media, media, printing/publishing and technology, specifically educational tech companies, consumer antivirus providers and domain/web hosts.  

At the same time, we remain focused on diversification across sectors such as financials, especially banks, which have large protective moats, and other cyclical industries like manufacturing, where there might be earnings volatility, but the underlying business is robust, ultimately supporting return of capital.

Selectivity to Capture Value and Avoid Loss

Given what has already unfolded this year—and what may still lie ahead—we remain intensely focused on security selection and deliberate positioning to capture value while avoiding permanent loss. We are not in the business of catching falling knives; we would rather let them land, assess the damage, and then move in selectively when valuations, fundamentals, and liquidity conditions truly justify taking risk.

That discipline matters because apparent calm in rates and credit can mask meaningful fault lines—from policy and political uncertainty, to fragile assumptions embedded in term premia, to the second-order effects of AI disruption and AI capex on balance sheets. Our response is to diversify across geographies and rate cycles, emphasize fundamental resilience, and size risk carefully—so that when dispersion rises and markets misprice uncertainty, we can act decisively rather than react under pressure.