How fixed income investors can strengthen their core with flexible bond strategies 1

A confluence of cycles How fixed income investors can strengthen their core with flexible bond strategies

Authors In brief • Fixed income investors face an increasingly complex investment landscape as unique, once in a lifetime monetary, credit and fiscal cycles converge amid elevated geopolitical uncertainty and dynamic bond–equity correlations. • The outlook for interest rates is uncertain, given contrasting Jemma Clee expectations for the near-term and long-term effects of artificial Head of International Investment intelligence (AI) on inflation, labour markets and the broader Specialists, Global Fixed Income, Currency & Commodities (GFICC) economy. ‘Fresh thinking’ at the US Federal Reserve under the leadership of newly appointed chair Kevin Warsh injects additional uncertainty, structurally increasing the potential for volatility across rates markets and curves. • In credit markets, a fast-moving AI capex supercycle is driving record public and private debt issuance, accelerating dispersion into AI ‘winners and losers’, for each stage of the AI roll-out, and increasing the need for rigorous bottom-up credit analysis. Jasper Sagoo Unconstrained & Income Investment • A major fiscal shift is also underway, with governments Specialist, GFICC running widening deficits even while growth remains resilient, potentially increasing curve volatility and dispersion across sovereigns, sectors and maturities as investors digest the extra supply. • Fixed income investors can strengthen their core portfolio exposure by allocating to strategies that are managed without traditional benchmarks, providing nimbler and more flexible ways to capture opportunities and manage risks effectively.

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Fixed income investing in a confluence Policy rate cycle: Getting ready for of cycles paradigm shifts Global markets are being shaped by a shifting outlook The global economy has seen a step-function rise in for interest rates, rapid AI adoption and fiscal expansion. political and geopolitical uncertainty. The onset of the This confluence of cycles is taking place against Iran conflict pushed Brent above $126 per barrel on an an increasingly complex geopolitical backdrop and intraday basis triggering a rapid hawkish repricing in dynamic bond-equity correlations. Together, these forces central bank expectations away from the cuts that had are creating a fast-changing investment environment been the base case. While energy prices subsequently with a wider-than-usual range of potential outcomes. fell from these initial highs, energy remains volatile, keeping central banks vigilant and rate markets highly sensitive to geopolitical developments. These Exhibit 1: Interest rate, AI and fiscal cycles are colliding geopolitical gyrations have also had ramifications for portfolio diversification, shifting bond-equity correlations and, at times, reducing the effectiveness of duration as a hedge for growth sensitive assets. Rates AI • Energy shock • Hyperscalers capex At the same time, newly appointed US Federal Reserve • Labour markets • Credit dispersion (Fed) chair Kevin Warsh is embracing ‘fresh thinking’ • Fed transition INVESTMENT • Productivity shifts at the US central bank with the greatest impact on OPPORTUNITIES AND RISKS global financial conditions. Markets continue to be challenged in determining the Fed’s reaction function, with initial perceptions of hawkishness abruptly shifting to dovishness following July’s Federal Open Market Committee meeting, prompting the yield curve to twist- steepen. The post-meeting press conference appeared Fiscal • Deficit expansion to leave more questions than answers, compounded • Supply pressure by the deliberate absence of forward guidance. Warsh • Term premia reiterated that “inflation remains elevated relative to the Committee’s 2% goal," even as policy rates sit at levels widely viewed as restrictive relative to estimates Source: J.P. Morgan Asset Management. of neutral.

We expect those neutral rate assumptions to be tested as AI adoption reshapes productivity, labour-markets and inflation dynamics. Combined with Warsh’s…