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Fixed income has often been thought of as a boring asset class. It is a safe and steady way to generate income and preserve capital over time, but the trade-off is typically lower returns relative to risk assets like stocks. But in early April that predictability skipped a beat when US tariffs sent tremors through bond markets, the like of which rarely seen since the global financial crisis.

However, volatility also created a window of opportunity. With expectations for equity returns now low, could bonds ride on the tailwind from lower interest rates and outperform stocks for the year?

To answer that question we have to start in the beginning. US Treasuries had sold off along with the rest of the bond markets in April, with wild swings in the 30-year yield. Tariff tensions exacerbated downside risks about US inflation and growth, and at the same time equity freefalls and the unwinding of leveraged positions compounded matters.

Although Treasuries eventually stabilized, the damage has been done. For a long time, the US has managed to keep Treasury yields relatively low due to their special status as reserve assets and the US dollar’s role as a reserve currency. This perception of safety and implicit guarantee is now being questioned, regardless of where we land on tariffs.

Fiscal concerns are certainly playing a bigger role in pricing Treasuries, even though these concerns are widely known. Moody’s recent downgrade of the US outlook to negative was not unexpected, following Standard & Poor’s in 2011 and Fitch Ratings in 2023. Despite the more-than-10-year gap since the first downgrade, the issues cited are well understood. In our view, this action does not directly pressure Treasury performance; it merely brings its rating in-line with other agencies.

Practically speaking, the difference between AAA and Aa1 is minimal in terms of default probability and expected loss. It only becomes a problem when a rating falls much further down the scale. What really matters is the changed dynamics in the global sovereign debt market and the pace at which prices often respond; investors have understandably become quite short-sighted. While a 5% yield for 30-year Treasuries might seem attractive in the short term, the view could be very different with a 10-year time horizon.

That said, it is premature to call the end for Treasuries, or the US dollar. Although the idea of de-dollarization has been discussed for years, it has largely remained theoretical. The dollar continues to be central to the global economy despite the search to find new reserve currencies. Yet, we may now finally be on the brink of a major structural shift.

While the rethinking of the dollar has intensified, the transition away from US assets will be slow — if it happens at all — and could take years. What we have seen though is not investors selling dollar-based assets but, instead, new investments are being made in other currencies. This diversification will take time and could eventually lead to a weaker dollar.

The dollar lacks a strong alternative. Although European Central Bank Chief Christine Lagarde believes there is an opening for a “global euro moment,” no significant flow has materialized yet. Longer term, however, we think the euro has the potential to earn more influence and play a larger role internationally.

For a fixed income portfolio, separating bond and currency risks has never been more crucial. Traditionally, when bond yields rose, the corresponding currency also strengthened. But today, US yields are rising yet the dollar is falling. We anticipate foreign exchange to be the primary source of volatility for the remainder of this year – currency fluctuations could easily negate all bond returns.

Investors with significant unhedged US dollar exposure could consider diversifying into local currencies with potential for higher valuations, especially the Taiwan dollar, Singapore dollar, Australian dollar and Philippine peso, as well as some Latin American currencies. It is also important to distinguish between hedging and selling the US dollar, as we stay relatively neutral. In the end, the goal is to avoid a single-currency portfolio scenario and minimize the risk of over concentration.

Needless to say, tariff developments have created a challenging situation for the Federal Reserve (Fed). If tariffs lead to higher inflation and prices stay elevated, target interest rates will likely remain at their current level for some time. Because the Fed was slow to raise rates after Covid, it is keen to avoid making the same mistake again, despite political pressure to do the opposite (i.e., ease). But if economic growth slows in tandem, it would be hard for the Fed to lower rates to support the economy.

While we anticipate the first cut in the fourth quarter, we avoid taking bets on the long end of US duration and focus more on the short end. From a global perspective, we prefer exposure to interest rates in the euro, UK, Australia and New Zealand. The central banks in these countries have a clear runway to deliver cuts; their future rate movements are more predictable than those of the Fed.

In this state of high uncertainty, diversification with a mix of positions across duration, yield curve, countries and credit markets makes the most sense to us. Given the quick shifts in market direction, we avoid taking outright directional bets that only profit from one possible outcome. Instead, we focus on countries and markets that are priced more reasonably, and we like credit investments.

Leading up to April, the environment for credit markets was favorable. Companies found it easy to issue debt, and the number of new issues was substantial. Often oversubscribed, the debt was well absorbed into the markets, with risk premiums near zero or even negative. Overall, credit metrics remain strong.

Although spreads in investment-grade (IG) and high yield (HY) credit are tight compared to recent years, a longer-term perspective shows a different picture. Since the global financial crisis, corporate fundamentals have improved significantly. For example, the composition of US and European credit markets has changed meaningfully, resulting in a higher quality and better overall investment universe. Therefore, despite the rapid movements in credit spreads in April, yields are near historical highs. We see potential for credit markets to perform well, as companies can weather a period of slower growth. Given better market dynamics, we also prefer European credit over US credit.

There is also a tendency to focus too much on the US and Europe; the most underappreciated opportunity in fixed income today lies in emerging markets. Despite the attractive valuations of emerging market credit, investor interest and capital flows lag other markets, and the gap is especially glaring in Asia high yield.

Last year, the market made a remarkable recovery after struggling from 2021 through 2023 mainly due to defaults in Chinese property developers. It has since become much more diversified in terms of both countries and sectors. The proportion of China real estate in the Asia high yield market has drastically decreased from 38% five years ago to about 7% by the end of May 2025.¹ Chinese credit and in particular high yield has performed well in the past 18 months. In our view, corporate fundamentals for Asia high yield are comparable, if not better than, US high yield. Furthermore, the default rate is expected to drop further in Asia, making it a promising area for credit.

Back to the question at the start: could fixed income outperform equities this year? We believe it is possible. In this whirlwind of uncertainty, fixed income has emerged as one of the most interesting asset classes to watch and invest in. The usual certainties are out the window, making future outcomes harder to predict.

This is where active management becomes crucial. By diving deep into our research and making quick adjustments as markets shift, we can seize opportunities as they arise. A global approach allows us to be both opportunistic and selective, which is vital given that geopolitical events now pose significant risks to credit markets. Trade-related uncertainties will linger, keeping markets volatile but at the same time potentially offering attractive entry points for savvy investors.

^1. Source: �۶���Ƶ Asset Management, J.P. Morgan, as of end May 2025