In its 2025 forecast, State Street projected opportunities in sovereign bonds, particularly US Treasuries, while cautioning about risks in investment-grade and high-yield credit.
The firm’s senior investment strategist, Desmond Lawrence, said government bonds across most advanced economies should provide attractive returns as central banks’ worries about inflation ease and they begin to align policy rates with weakening domestic demand and international activity.
A key factor supporting Lawrence’s bullish stance on bonds is the long-term demographic trends that suggest muted labour force growth and productivity, which should cap trend growth across advanced economies.
This structural limitation is expected to anchor sovereign yields, providing medium- to long-term support for bond returns, he explained.
“We believe a soft landing can provide returns in the mid-single digit range as investors capture relatively generous yields and a generally favourable roll effect,” said Lawrence, adding that this varies by country in line with current absolute yield levels.
“US Treasuries look comparatively more attractive versus core eurozone bonds, where the starting position is very different and thus offer more moderate returns. A harder landing would amplify returns – potentially into double-digit territory,” he noted.
“Substantial fiscal deficits and debt levels remain a distinct, and so far unaddressed, challenge. While the US captures most of the attention, especially considering the election result, ageing populations make this just as pressing an issue in Europe and Asia. This represents the most obvious risk to an otherwise encouraging outlook.”
In the credit space, State Street sees limited room for further compression in investment-grade (IG) spreads, which are nearing historical lows.
“Average credit fundamentals are still solid, but it seems reasonable to expect some deterioration in balance sheet strength and interest coverage as the credit cycle progresses,” said Lawrence.
“Indeed, there are already signs of this: although leverage among US non-financials has declined from its pandemic-era high it has risen once again from recent lows. Meanwhile, profit margins at those non-financials have recently reached an all-time high – unless that trend continues, it seems unlikely that interest coverage for this segment can improve and may weaken further.”
Lawrence noted that high-yield debt mirrors the position of investment-grade credit, with spreads at their tightest since 2007, making returns more reliant on declining underlying yields than on further spread compression.
Meanwhile, he pointed to emerging market debt as an area of interest, particularly hard currency debt, as narrowing spreads and a turn in the US rate cycle could provide opportunities for investors. However, he cautioned that varying domestic conditions in emerging markets will influence the pace of policy accommodation.
The bottom line, according to Lawrence, is “a generally favourable environment for advanced economy sovereign debt”.
“As fiscal, trade and monetary policies evolve, we expect to see swings in sentiment and bouts of volatility – potentially creating opportunities for investors to manage or extend duration. Credit investors faced with limited scope for further spread compression and a maturing credit cycle can also expect dispersion and volatility – a fruitful regime for an active approach to credit.”
