Backdrop for bond investors appears favorable

The outlook for 2025 for global fixed income investors can be summed up in one word, which is carry. This is a carry environment. Inflation around the world is in a bottoming process, which will probably run its course through most of 2025. That'll keep central bankers, at least on the sidelines, if not easing in most major developed economies. So that's a good backdrop for fixed income investors.

The economy in the US is likely to soft land. Other economies are entering in a more-- less softer landing, in the case of Europe, or maybe even a mild recession. And China is also grappling with its own challenges with growth, so growth has decelerated. That's not such a bad backdrop for bonds. And as we move forward into 2025, we think a lot of the capital gains behind us, but you can earn a very decent amount of carry and still maintain that nice ballast in your fixed income portfolios.

Budget deficits have a tendency to be inflationary over time. They keep interest rates elevated both in real terms and inflation terms. So we think that over the next 10 years or so we're likely to see higher highs and higher lows in interest rates. This cycle is still in its bottoming phase for inflation. But as we move through this cycle, the concern that we need to look for is, are those budget deficits going to continue to put pressure on the amount of supply of treasuries that have to hit the market and clear the private sector. The clearing price is the yield that'll provide a lift to real yields. And if we look at on the inflationary side, fiscal policy has provided a stimulus to the economy to the tune, in the United States, of 3/10 to 5/10 per quarter in GDP growth, which, again, can add to over extended or frothy type of economic conditions and, therefore, inflation. So those factors we have to keep in mind.

What I find interesting as we exit 2024, is that the financial markets tend to be giving the incoming Trump administration a lot of the benefit of the doubt. If we look at the risk markets, for example, equities, credit spreads, they're trading at relatively tight levels, which is an expectation that growth is going to remain strong, inflation will remain in check, and so forth. From my perspective, I think it's quite uncertain how these policies play out. I see a number of contradictions in them. For example, closing the border, restricting immigration has the effect of obviously reducing the growth in the labor supply. We already have a reasonably tight labor market, so we have to think about how that affects inflation and wage inflation. There's also talk from the administration to reduce the deficit yet also to attain a high level of growth. And those factors seem at odds, at least over the near term, because cutting the deficit would obviously reduce the fiscal stimulus that has added to the buoyancy in the economy. So reducing that would actually potentially miss their longer term growth targets.

I think private credit is here to stay. It'll be an area of growth again in 2025. We see an ongoing convergence between the public and private debt markets in terms of who's underwriting the securities and who is actually purchasing or putting them on their so-called balance sheet. When we look at private, that had traditionally been the domain for insurance companies and that over the years now has spread to all different channels within the investing universe. And private credit has expanded to include all types of securities that we have typically seen in the public space. There is a premium to invest in credit for the illiquidity as well as the complexity and the structural factors that go into that. And I think that's something that adds a lot of value for investors to think about, if they can tap into those types of deals.

The liquidity is actually another area of graying. And we're seeing efforts now to provide a nascent secondary trading markets in a lot of these private securities. So that's an area that I think over the next several years will continue to grow. That is liquidity and expanding secondary markets in the private sector. Loomis is taking advantage of the opportunities in this space. We're focusing most of our attention on the investment grade private credit area, where we can find solid investment grade rated credits rated single B, triple B, even dipping down to the double B part of the credit quality market. And we're getting significant pickup in yield relative to the opportunities we see on the public space. But we're also getting substantially better structural features that increase either our security or the security of getting paid back by the end borrower.

Going into 2025, we think that investors should feel comfortable moving out the yield curve. Cash is vulnerable to the possibility that rates could continue to fall so that reinvestment rate risk is still there. We look at the United States, for example. While there's some question mark on how many more cuts the Fed will enact, we do think that there's still more likelihood for cuts than certainly for hikes. So as much as another 75 to 100 basis more basis points of cuts are still a very high possibility into 2025.

So you got to think about that reinvestment rate risk for cash. That's why we would suggest move out, lock in some of those yields in the intermediate part of the curve. That seems to be a good balance between taking duration risk and avoiding that refla-- reinvestment rate risk but also the risk that the Fed or the economy starts to accelerate, inflation starts to accelerate.

The bright spot for fixed income investors in 2025 is the carry that you can earn in the marketplace. Inflation continues to bottom in most developed economies and that will keep most central banks in an easing mode or at least keeping their policy rates at an even keel. So as inflation bottoms, we're getting yields. You look in the United States are getting yield around 4% through most of the yield curve. So you're earning a very good real yield by historical standards of 2% or more. You're getting a break even of 2% or more in your-- in the composition of your nominal yield. And that's quite attractive by historical standards. So this is an area that, look, the capital gains are mostly behind us. But the carry that can get in your portfolio is very attractive. And now you're also getting that ballast in case of rocky times ahead. So it's a good ballast in your portfolio and an anchor to windward.