Eric Souders

The year ahead is shaping up to be a crossroads for global market investors, marked by continued uncertainty around economic growth and central bank policy, according to Eric Souders, portfolio manager at Payden & Rygel.

“Economic signals remain mixed. The US labour market has weakened, but demand has not broken. Growth continues to look resilient, supported by strong, technology-led investment,” said Souders. “Inflation in the US has declined, and we believe it can continue to improve, even as the outlook for economic growth remains uncertain.”

Despite easing inflation, policy uncertainty remains elevated, particularly in the US.

“The upcoming US mid-term elections later this year are likely to generate heightened and often extreme rhetoric,” he said. “Investors will need to strike a balance, being responsive to actual policy actions without becoming overly reactive to political noise.”

Souders expects the US Federal Reserve to remain on hold in the near term, noting that leadership changes will be a key factor influencing policy decisions.

“The Fed is entering a period where leadership transition becomes increasingly relevant, which limits the scope for near-term action,” he said. “We do not expect rate cuts before mid-year. While we believe the Fed will cut rates several times in 2026, markets are currently pricing in just one cut through the US summer.”

He added that bond markets are reflecting this uncertainty.

“The front end of the US yield curve is expected to remain relatively contained. However, we are cautious on the long end of the curve, which has been driven more by policy dynamics than economic fundamentals. In our view, investors are not being adequately compensated for the level of volatility they are assuming in the long end of the curve.” 

Looking ahead, Souders forecasts US economic growth of between 1 and 2 per cent, driven by a narrower set of factors.

“Wage growth has slowed significantly, and current immigration policies are contributing to a decline in population growth of around 1.5 per cent per year,” he said. “Together, these factors are weighing on the US economy’s potential growth rate.”

Souders believes elevated US policy uncertainty creates a compelling case for diversification into emerging markets.

“Globally, investors remain heavily overweight US assets, across equities, public and private credit, and real estate,” he said. “These assets are all ultimately reliant on a single driver: the US consumer. With labour markets softening and consumer sentiment under pressure, that concentration risk is becoming more apparent.”

“Emerging markets, by contrast, are less exposed to the US consumer. Inflation is largely contained, growth remains strong relative to developed markets, and valuations are attractive,” he added.

“These fundamentals point to a constructive outlook for emerging markets in 2026, and we expect them to perform well relative to developed markets.”

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Eric Souders

The challenges fixed-income markets face are rising, with inflationary pressures potentially denting bond prices as US President Donald Trump proceeds with tariffs which could also depress global economic activity. These factors will play an important role in shaping the trajectory of bonds markets in 2025, according to Eric Souders, director and portfolio manager with Payden & Rygel. 

In a landscape of shifting economic forces and greater bond market volatility, ‘Bond Wars’ could unfold this year, and with that, a flexible and adaptable investment approach, or absolute return strategy, is required to deliver reliable income for investors and avoid capital losses on bonds, according to Mr Souders.

“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. 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,” he said.

Mr Souders favours the flexibility to invest in certain fixed income asset classes while avoiding others, which will be key for investors retaining their capital. 

“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,” he said.

Already this year, US government bond yields initially jumped, but have since fallen back to multi-month lows after results from a US manufacturing survey in March suggested slowing growth in the world’s biggest economy. 

“An absolute return fixed income strategy is important in the current uncertain environment, with greater volatility in bond prices,” Mr Souders said.

“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.” 

According to Mr Souders, growth in the US has been above 5 per cent in nominal terms for seven out of eight quarters and above 2.5 per cent in real terms for seven out of eight quarters. Asset prices, including US equities and housing prices, are at or near all-time highs, while credit spreads are near 20-year lows, which all put downward pressure on bond prices heading into 2025. 

“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,” he said.

Unlike core bond strategies, which are driven by market benchmarks, an absolute return strategy does not rely on a benchmark and typically starts with cash. This provides fund managers with greater flexibility to adapt to changing market conditions, focusing on reasonable returns relative to cash while prioritising capital preservation, according to Mr Souders.

“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,” he said.

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Nigel Jenkins

Bond markets have become increasingly volatile over the last couple of years. In the first few months of this year alone, the market has gone from confidently expecting interest rate cuts to an environment where inflation is sticky and rate cuts are in doubt. Bond yields have accordingly jumped again so far in 2024. Active bond management offers investors downside protection and the potential for higher returns, according to Nigel Jenkins, managing director at Payden & Rygel who shared his views with GSFM during a recent visit.

“The active management of bond investments and flexible asset allocation is more important than ever as economic uncertainty and volatility increases. Just this month, we have seen a sharp rise in Treasury yields to year-high levels as expectations drop that the US central bank will cut interest rates this year, given persistently high inflation in the US.

“This underscores the need for nimble management of bond allocations. Active managers can anticipate and respond to such market events and adjust bond asset positioning accordingly to minimise losses and maximise gains. This agility is crucial in today’s uncertain economic environment, especially with more potential shocks to come in 2024,” Mr Jenkins observed.

The US presidential and congressional elections take place in November, and those outcomes could also be very influential on bond prices and broader financial markets.

“We are watching for potential fireworks. Even before then, there could be other fireworks and surprises from European Central Bank policy decisions, from inflation releases in developed countries and other elections around the world,” he said.

“As we have entered a new regime for financial markets, where close to zero interest rates are no longer the norm, we are likely to see higher volatility not only in interest rates and credit spreads, but also in equity values and economic variables (inflation and growth) for the next one to two years at least. As a result, having flexibility around asset allocation decisions, being able to adjust bond duration and credit risk without being tethered to a benchmark, is very important for fund managers to be in a position to protect investors’ capital and produce income.

“Investors need to act quickly to best preserve their capital and take advantage of opportunities, where they emerge. The fixed-income investment universe is very broad, including developed and emerging market government bonds, investment grade and high-yield corporate bonds, bank loans and other debt assets. So, you need experts to navigate such a huge and diverse asset class,” Mr Jenkins said.

Importantly, while passive funds offer low fees, they will lock in net of fees underperformance versus benchmark. Active management, on the other hand, is able to prioritise risk management and seek to protect investors’ principal.

“An absolute return strategy is untethered from traditional benchmarks, so managers can invest where they see the best risk-adjusted returns in the bond market. In addition, active managers have several tools that can help produce alpha and offset downturns, such as varying bond duration, the careful selection of sectors and securities, as well as the active management of geographic and currency exposures.

“The aim is to generate income and preserve capital while containing volatility. Contrast that to passive managers, where a manager must work with a given bond benchmark and rigidly allocate investments. Managers are not able to reallocate portfolio assets across different sectors or respond to market developments.”

Given that opportunities in fixed income will shift over time, asset allocations should not remain fixed during a credit cycle. The active manager can recognise and add value by identifying opportunities across a broad spectrum of perspectives across multiple bond sectors and issues, and add alpha when dispersion is elevated. While some absolute return funds charge higher fees, that can be a small price to pay for the prospect of better capital protection and superior performance over time according to Mr Jenkins.

“As active managers of a fixed income absolute return strategy, before we consider the direction of markets or the value opportunities that are presented, our first responsibility is to protect an investor’s principal against the potential for loss. Risk management is paramount.

“The foundation of our strategy is a relatively short-duration fixed income portfolio where risk premia from global credit markets and interest rate curves may provide dependable and repeatable returns.

“Diversification – the ability to move between multiple sectors that aren’t perfectly correlated with each other just smooths return over time. It’s a good part of the market to have an active manager be in a position to respond quickly to new market developments. And if the last three or four years have shown us anything, it’s that things can happen very quickly that cause a rapid change in market perceptions and the value of securities. The fund puts investors’ capital in a position to be able to respond promptly to new developments,” he said.

The Payden Absolute Return Investing (PARI) strategy is distributed in the Australian market by GSFM.

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Payden & Rygel, portfolio manager, Eric Souders says that bonds provide good prospects for potential returns on a risk adjusted basis, particularly versus more risky asset classes like equities, but he added it could be time for a rethink on their place in a traditional 60/40 portfolio.

“We believe the traditional 60/40 portfolio could be recalibrated to include more multi-asset strategies.

“With an expected downturn in the global economy, it is important for investors to look to active management. They need to have more latitude around stock selection, and more latitude around interest rate duration, and not necessarily be tethered to a specific benchmark.

“The bottom line is that bonds should play a more prominent role in portfolios today. But on the 40 side of that 60/40 equation, investors can perhaps be more creative around the types of bonds they are buying,” says Mr Souders.

He adds that the current macro economic environment opens up favourable opportunities to invest in higher quality bonds which are providing good yields.

“Yields are higher across the board in fixed income, which has not been the case for the past three to five years.

“When constructing a portfolio and deciding where to put capital, higher interest rates means including cash is more a comfortable decision for investors. The same is true for those looking to invest in government bonds and high-quality investment grade corporate bonds.

“Bonds offer good running yield potential, of a much higher quality, plus potential price upside.”

Mr Souders says credit spreads are still tight, but investors are now well compensated to hold higher quality securities.

“Today you are getting paid to own higher quality securities. You don’t have to reach for yield. In fact the ‘reach for yield’ is almost the reverse of what it was years ago.

“Similarly, you don’t have to reach down the credit quality spectrum, or head further out on the yield curve, for returns. This means investors can be more conservative and defensive at the front end.”

He concedes the front end is controlled by central banks and government policy, so there is the potential for volatility.

“This potential volatility can be mitigated by applying a strategy that focuses on absolute returns, is concentrated on the zero to five year maturity spectrum, and moves capital toward higher quality assets,” says Mr Souders.

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