As the US president’s policies take hold, we explore the effect on global bond markets.

It is shaping up to be a volatile year for global bond markets, thanks to the uncertainty created by US President Donald Trump’s new policies, persistent inflation, growing geopolitical risk and fears of a global economic slowdown.

On the plus side, government bond yields finally look attractive after more than a decade of ultra-low interest rates, and some investors are taking comfort from the negative correlation between equities and bonds, which became clear after equity markets sold off in mid-February.

What is the rest of 2025 likely to hold for global bond markets?

To understand the potential path ahead for the US, the world’s largest bond market, Canaccord Genuity Wealth Management multi-asset strategist Thomas Hibbert says it is essential to understand what is driving Trump’s economic policies. He points to a paper published last November by Stephen Miran, now the president’s chief economic adviser. A User’s Guide to Restructuring the Global Trading System explains why the US government is trying to rewire the global financial system. Tariffs form an important part of this strategy.

‘The US wants to do this because it effectively has too much debt,’ says Hibbert. ‘It runs a dual trade and budget deficit because it has too much debt and interest costs are too high. This situation is unsustainable.’

The strategist notes that last year the US spent more on debt interest than defence for the first time – an event interpreted as a sign of structural decline.

‘Trump is happy to accept short-term pain and volatility to get the 10-year Treasury yield down, implementing this very ambitious policy to structurally change the economic system,’ says Hibbert. ‘It is a massively interesting time.’

He says the president is measuring the success of his second term in office by the direction of travel of the 10-year Treasury yield. The US stock market had been his main focus during his first term.

Andrew Wilson, chief investment officer (CIO) at Lockhart Capital Management, echoes these sentiments: ‘The US administration wants to see lower Treasury yields, having understood the dire fiscal position it finds itself in and having received something of a hospital pass from former Treasury secretary Janet Yellen.’

Wilson says yields could come down if the government manages to reduce the budget deficit. Also, Opec+ pumping more oil should lower energy prices, which should feed through to dampen inflation.

Nevertheless, the CIO notes that the cost-cutting efforts of the Department of Government Efficiency, headed by Tesla co-founder Elon Musk, are likely to impact the economy negatively over the short term.

Inflation is here to stay

While the Trump administration claims tariffs are not inflationary, others disagree. They point to higher prices of imported goods and the potential for supply chain disruptions.

Hibbert suspects US inflation will stay above target, making it difficult for the Federal Reserve to cut rates. He forecasts only one rate cut this year, not the two that officials expect.

Portfolio manager Martin Coucke, who runs the Schroder Sustainable Bond fund, expects three rate cuts, though says the uncertainty created by the new administration’s policies makes it difficult to forecast inflation.

‘We have seen sentiment on growth turn sharply negative in recent weeks,’ he says. ‘Policy uncertainty is affecting the ability of businesses to plan and make investment decisions, and this is starting to show up in business surveys and confidence measures.’

In its latest predictions, the Fed has cut its GDP growth forecast for 2025 to 1.7% from 2.1% and expects inflation to end the year at 2.7%, versus its previous estimate of 2.5%.

Despite slowing growth, Coucke’s team is not forecasting a recession.

‘The growth and inflation outlooks align more closely with a soft landing,’ he said.

Hibbert points to factors that are ‘both pushing and pulling’ the dollar, interest rates and bond prices in the US.

‘I expect volatility. Fundamentally, we are in a higher-for-longer environment,’ he says.

While inflation expectations continue to rise at a time when bonds have generally performed well, Hibbert says inflation breakevens have widened, which means short-dated Treasury inflation-protected securities (Tips) look expensive. With this in mind, Canaccord has been buying medium- and longer-dated Tips, having reduced its allocation to conventional Treasuries.

Some of this allocation has gone into gilts, where the team is spotting better value compared with conventional Treasuries.

UK fumbles

In the UK, Hibbert notes the government is spending too much and is concerned some policies will prove inflationary, such as the employers’ national insurance increase and the ending of VAT exemption on private school fees. He expects two rate cuts from the Bank of England this year.

Wilson believes the new Labour government has ‘fumbled the ball’, missing out on an opportunity to attract international investment and improve business confidence.

‘Whether there is a genuine attempt made at a reset or even a change at Number 11 Downing Street remains to be seen,’ he says. ‘We are left with a highly indebted and flatlining economy with low rates of productivity, which is always vulnerable to inflation.’

Is 60:40 alive and well?

Given the uncertainty and high government debt levels across many Western nations, what role can bonds play in a multi-asset portfolio today?

Bonds look compelling at a time when yields are high and geopolitical risk is elevated, according to Richard Carter, head of fixed interest at Quilter Cheviot.

‘There are also concerns the global economy will slow, with the US in particular suffering as Trump’s trade policies take time to produce his desired effect,’ he says. ‘While inflationary pressures may be present, rates still need to come down this year, which will ultimately support bond prices.’

In Carter’s opinion, bonds can act as an ‘attractive diversifier’ today.

‘We have seen equities sell off sharply in recent weeks but, unlike in 2022, bonds have remained resilient.’

Quilter favours both UK and US markets with a bias towards sovereign and higher quality investment grade debt, pointing to tight spreads in some of the riskier parts of the market.

‘We also continue to see a lot of interest in tax-efficient, low-coupon gilts given the return profile on offer and tax advantages,’ Carter says.

Hibbert expects a more dynamic relationship between bonds and equities this year against an inflationary backdrop.

‘If we see a material economic slowdown, government bonds are going to dampen equity volatility,’ he says. ‘They are going to protect portfolios, which means they are valid and viable in a multi-asset context.’

Avoiding the long end

Nevertheless, Hibbert suspects there could still be periods when correlations between equities and bonds turn positive. He believes it is important to be short duration and hold investments that can perform in an inflationary environment, such as alternatives and asset-backed securities.

He says 60:40 portfolios can still work but bond allocations must be actively managed.

‘You need to avoid the long end and instead focus on the belly of the curve and the short end,’ he says. ‘We are cautious that bond vigilantism is on the rise, so we expect steeper yield curves. Also, you should have an allocation to alternatives.’

Wilson also sees little benefit in taking longer-dated risk for little extra yield.

‘It is difficult to see how the West can shrug off its debt burden, certainly without inflation, and so long-dated paper is simply not attractive,’ he says.

Divergence in bond markets

Looking ahead, Coucke expects to see continued divergence across global bond markets, which he says will provide opportunities to add value.

‘The market has already moved rapidly to discount European fiscal convergence with the US, but we think this theme will continue to play out over the medium term,’ he says. ‘We expect this to lead to continued compression of the spread between bunds and Treasuries.

‘Bonds offer scope for capital appreciation as central banks continue to ease monetary policy. Importantly, bonds are now providing attractive levels of income, which helps protect total returns in periods of weakness.’

Extract from Citywire – March 2025