CIO Views: Steady income should not be overlooked
- 06 February 2025 (5 min read)
Steady income should not be overlooked
Many bond investors have been enjoying higher income returns as the average rates (coupons) being paid on bond indices has been rising since 2021 and are likely to continue to do so as lower coupon bonds issued before 2021 mature. Over the past decade, the compound income return from a typical US dollar investment-grade index has been around 4%; in Europe, it has been just over 2%. For US dollar high yield, it has been close to 6.5%. Given the rise in average coupons, income returns should potentially be higher going forward. But bond prices can be volatile. To manage this, investors may choose strategies with less price and interest rate risk – like short-duration bonds. But overall, we believe - given the broad increase in yields – that income levels are becoming more attractive. With uncertainty surrounding the economic outlook, steady income returns should not be overlooked.
European government bonds: Liquidity-driven valuations
Investors might have noticed the rather large swing in valuations of German government bonds (Bunds) relative to interest rate swaps – an agreement to exchange one stream of future interest payments for another - in the post-COVID-19 period. Between 2020 and 2022, Bunds became relatively more expensive. Since then, they have cheapened; Bund yields have risen by 100 basis points relative to swaps.
Post-pandemic government bond buying impacted the perceived scarcity of funds, thus raising liquidity concerns for Europe’s benchmark bond and pushing relative valuations to extreme levels. Similarly, the European Central Bank’s decision to dial back its unconventional monetary policy from July 2022 put a lid on the liquidity spectre. As with some other European government bonds today, the relative cheapness of Bunds may tempt relative value investors, although political and fiscal concerns will remain.
Region in waiting
Asia’s economic environment has become increasingly challenging from a growth, monetary policy, and currency perspective. US monetary policy and the greenback strength are among the main challenges, with the US trade policy as the primary threat. While inflation eased in most Asian economies in 2024, the average remains above most central bank targets. The Federal Reserve’s (Fed) policy path remains critical as it could intensify capital outflows from countries that ease rates too aggressively. Most Asian currencies have depreciated, particularly in the final three months of 2024, as expectations for fewer Fed rate cuts grew. Currencies will likely be the pressure valve for adjusting to any growth shock from tariffs, with regional correlations likely to move higher initially, before policy choices, and relative budgetary space in various economies, help differentiate the strong from the vulnerable.
Asset Class Summary Views
Views expressed reflect CIO team expectations on asset class returns and risks. Traffic lights indicate expected return over a three-to-six-month period relative to long-term observed trends.
| Positive | Neutral | Negative |
|---|
CIO team opinions draw on AXA IM Macro Research and AXA IM investment team views and are not intended as asset allocation advice.
Rates | Budgetary concerns and US politics suggest higher volatility even if rates in fair-value range | |
|---|---|---|
US Treasuries | 10-year yield likely to stay below 5% unless view on direction of Fed policy changes | |
Euro – Core Govt. | German Bund yields reflect weak growth outlook and lower ECB rates | |
Euro – Peripherals | Spain continues to be preferred; French government bonds subject to ongoing political risk | |
UK Gilts | Bank of England expected to cut rates in February; market anticipating fiscal update in March | |
JGBs | Bank of Japan’s January rate hike reflects inflation concerns; negative on JGBs | |
Inflation | While real yields are attractive, the break-even rate does not fully reflect inflation risks |
Credit | With growth resilient, investor confidence in credit remains strong | |
|---|---|---|
USD Investment Grade | Credit yields are attractive; elevated valuations create vulnerabilities if rates keep rising | |
Euro Investment Grade | Modest growth, alongside lower interest rates support credit’s income appeal | |
GBP Investment Grade | Returns supported by cooling inflation and deeper rate cuts than what is priced in | |
USD High Yield | Stronger growth, resilient fundamentals, and higher quality universe are supportive | |
Euro High Yield | Resilient fundamentals, technical factors and ECB cuts support total returns | |
EM Hard Currency | Attractive income from higher quality universe than recent history |
Equities | Growth backdrop supportive but risks of tariffs hitting global trade | |
|---|---|---|
US | Earnings growth supportive; performance more balanced as AI bubble somewhat deflates | |
Europe | Valuations are attractive; low return expectations could be exceeded by positive surprises | |
UK | Markets need to see how government can improve growth prospects; lower rates will help | |
Japan | Solid combination of valuations and expected earnings growth | |
China | Signs of improving confidence but foreign investors need to see more policy support | |
Investment Themes* | Competition in AI to create more opportunities for beneficiaries of technology |
*AXA Investment Managers has identified six themes, supported by megatrends, that companies are tapping into which we believe are best placed to navigate the evolving global economy: Technology & Automation, Connected Consumer, Ageing & Lifestyle, Social Prosperity, Energy Transition, Biodiversity.
Disclaimer
This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities. Due to its simplification, this document is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this document is provided based on our state of knowledge at the time of creation of this document. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.
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