“Flexibility and adaptability” necessary to to face market uncertainty

American fixed income specialist and GSFM partner, Payden & Rygel, has urged portfolio managers to adopt an absolute return strategy to continue to deliver reliable income for investors in the face of “shifting economic forces” causing bond market volatility, particularly as US President Donald Trump continues on his tariff trajectory.

Payden & Rygel Director and Portfolio Manager, Eric Souders, said this market uncertainty continues to fuel the potential emergence of ‘Bond Wars’, which is why an absolute return strategy that leverages a “flexible and adaptable” approach to investing would be necessary to ensure investor returns remain unharmed.

“As we move through 2025, the interplay of economic, fiscal, and political factors has created a landscape filled with both opportunity and risk for bond investors. We are likely entering a new regime characterised by higher volatility in interest rates, inflation, and credit spreads,” he said.

“The ability for portfolio managers to adapt, without being constrained by a bond benchmark, will become increasingly important this year in the face of greater uncertainty. Inflation dynamics remain in flux as a new US Treasury Department strategises the balance between fiscal and monetary conditions, and Trump’s second administration introduces important dimensions to policy and growth such as tariffs and US-focused policies.

“Market forces across the bond market can shift in both cyclical and structural ways. Cyclical shifts can occur rapidly, rendering forecasts outdated, increasing uncertainty, and driving price volatility across financial assets. Structural shifts typically take longer to unfold and require time to unveil unexpected plot twists. An absolute return fixed income strategy is important in the current uncertain environment, with greater volatility in bond prices.”

Souders said leveraging an absolute return strategy would allow fund managers to adapt to rapidly-changing markets, as it is not tied down by benchmark performance and is considered relative to cash.

According to Souders, US growth has sat above five per cent in nominal terms and above 2.5 per cent in real terms both for seven out of eight quarters; US equities and housing prices record all-time highs at the same time as credit spreads are at 20-year lows. This combination is set to put pressure on bond prices this year.

“The bond market is at an inflection point. Forces of light have been strong in the last two years, with solid growth, stable employment, and record-high asset prices. However, the dark side lingers as inflation remains elevated and bond market volatility is too high. Order must be restored as the key players in this saga aim to complete their various objectives,” Souders said.

“The US economy is doing well and does not need more growth, with some arguing it could even benefit from less growth. Donald Trump’s victory in the 2024 elections was largely driven by voters prioritising the economy, particularly inflation, over asset appreciation or economic growth. Tariffs have only added to inflationary pressures.

“The Payden Unconstrained Bond team envisions a potential plot twist in the Bond Wars, where bond yields must rise before they can fall. A rise in yields, particularly in longer-term maturities, would tighten financial conditions and temper growth expectations. As a result, the Unconstrained Bond team prefers less exposure to the long end of the yield curve.

“Conversely, the team finds the front end of the bond yield curve attractive, with two-year interest rates just above the Fed Funds Rate and aligned with the US Federal Reserve’s reaction function to any deterioration in the labour market or growth.

“The question remains whether the new coalition within the red wave, helmed by US Federal Reserve Chair Jerome Powell, US Treasury Secretary Scott Bessent, and President Donald Trump, can vanquish inflation, or if the scales will tip, reigniting the eternal battle between the forces of order and chaos lurking in the bond market.”