It's only January, and already 2025 is shaping up to be another complex and volatile year. Politics, evolving macroeconomics, and divergent monetary policy will dictate sentiment. The threat of a Trump-inspired trade war also looms large. We think this backdrop sets the stage for fixed income to deliver.

A Quick recap

In early 2024, concerns arose that headline inflation was proving to be stickier than expected. Nonetheless, central bank rate cuts finally materialised in the second half of the year, as anticipated.

In the last two months, Donald Trump's election victory pushed medium and long-dated Treasury yields significantly higher due to fears that his economic policies would be inflationary. Geopolitical tensions also added to the upward pressure on the yield curve.

Global economic growth was more resilient than forecast, with strong corporate profitability supporting credit spreads, which tightened significantly over 2024.

These developments had a mixed impact on fixed-income returns, with pure government bond strategies lagging the positive performance from corporate and emerging market strategies.

The higher all-in yields now available have heightened the attractiveness of fixed income. Several additional themes should further bolster the case for fixed-income investments.

Key themes for 2025

We expect monetary policy to diverge in developed markets. The US Federal Reserve has already pared back its rate-cutting cycle as it waits to see the impact of Trump's policies. Market consensus ranges from zero cuts to two in the latter stages of the year. By contrast, the European Central Bank, arguably behind the curve, looks set to cut deeper and quicker than previously forecast in the face of mounting economic headwinds. Stubborn UK inflation had given the Bank of England reason to pause. However, January's numbers were weaker than expected, opening the way for potential reductions.

Yields and spreads

Global IG bonds' all-in yields across developed and emerging markets are attractive. The yield to maturity on the Barclays Global Average Corporate Index is currently 4.8% compared to the historical average of 3.1% (going back to December 2004).  When comparing the past 10 years, the current yields available for all the main fixed income sub-asset classes are also well above the long-term average (see Chart 1). This should appeal to those coupon-clippers looking for an attractive income.

Higher yields also often lead to tighter spreads outside a recession. That said, the prospects for further spread compression could be more limited now that they are below long-term averages. Still, there could be some scope for spreads to grind lower, particularly on a selective basis.

Economic sweet spot

Turning to GDP, history shows that modest economic growth is typically better than high growth for IG credit. Starting in 1948, periods of 1-2% growth resulted in excess returns for IG. High growth (above 3%) was relatively poorer for IG. That's because, during phases of robust growth, focus tends to shift towards shareholder value at the expense of bondholder value. As it stands, we think 2025 will deliver modest economic growth, suggesting a good environment for IG credit.

A comparative advantage

Fixed income stands out compared to other asset classes on a risk and relative valuation basis. With strong fundamentals, higher yields, lower volatility, and a position higher up the capital structure, fixed income presents a lower-risk and potentially higher-return investment option to regular stocks. At the same time, five-year US Corporate yields are above the S&P 500 earnings yield (5.2% versus 3.4% [1]), indicating attractive relative valuations.

Moving beyond cash

There's also a compelling case for investors to transition from cash and money market funds into fixed income. With the ability to capture over 100 basis points in excess yield, fixed income offers a tangible opportunity for investors to enhance their returns while effectively managing risk. The potential upside could be significant. By our estimates, there's around US$7 trillion sitting on the sidelines, poised to enter the market.

Final thoughts...

The 'reasons to believe' in fixed income are clear. Yields are historically attractive, and fundamentals are strong. In a complex and unpredictable world, the asset class has a safety and valuation advantage over riskier assets like equities.

We believe embracing the fixed income opportunity could unlock significant value for portfolios, marking a timely strategic move in a world of turbulent economic, political, and market dynamics.

1. _{S&P, December 2024}

2024 was yet another positive year for the European & Australian Asset Backed Securities (ABS) markets with record issuance and continued robust performance and resilience. We review the year that was here, along with our key areas of focus for 2025.

Market stability and demand during 2024 has been supportive for issuance

The floating rate nature of the European ABS and CLO asset classes has provided stability during a year of continued interest rate and inflationary volatility. Against broader markets, spreads remained attractive to investors while the market stability provided a good backdrop for issuers. These conditions meant that European ABS Issuance reached post GFC records at €93bn in 2024 and activity was 40% higher than 2023 issuance levels. European CLOs also saw significant supply, with issuance excluding refi/reset activity also amounting to €45 billion, also a post GFC record. Australian markets went one better with an all time record for new issuance of nearly €50bn. This issuance spanned 100 individual transactions and showed the demand in the Australian market, as it absorbed the considerable supply with orderly, competitive pricing.

In UK/Europe, diverse range of collateral types and issuers, both bank and non-bank originators, contributed to investors having a wide breadth of deals and collateral to consider over the year. Notably, more than 50% of issuance in 2024 was distributed with investors, rather than retained, compared to 34% in 2023. This is an additional positive technical for the asset class as the investor base for the asset class has expanded, a timely boost as the central banks have stepped back from their purchase activity. Liquidity for European securitised products remains strong with secondary markets particularly active over the course of the year; JP Morgan note auction volumes of EUR 7.2bn, consistent with volumes seen in 2023.

As well as traditional sectors such as UK Prime RMBS, there has been significant supply across auto and consumer loan ABS. Notably, there were also first time deals in three sectors: European Solar ABS, UK Data Centre ABS and European Middle Market CLO. These transactions show the increasing importance of ABS as a potential funding tool for more esoteric asset classes.

As noted in our mid-year review, the ABS sector has benefitted from a favourable macroeconomic backdrop, contributing to positive sentiment. Supply-demand dynamics have continued to bring spreads tighter consistently through H2 2024, although to a more limited degree than seen in H1 2024.

Asset performance has been stable with mild deterioration observed during the year

The fundamental backdrop and asset performance themes from the first half of 2024 continued into the second half of the year, despite continued higher interest rates and stubborn inflation. Certain asset classes such as the UK non-conforming and UK Buy to let RMBS sectors - where collateral that was originated pre-GFC, continues to show performance deterioration with metrics suffering and further rating downgrades.

Regulatory activity continues to evolve

• European Securitisation Regulation: A consultation was launched in Q4 24 by the European Commission to gather feedback from the industry regarding a wide range of issues pertaining to the EU securitisation market.  The aim of the consultation is to contextualise, calculate and validate the experience of market participants across investors, issuers, and rating agencies, under the existing EU securitisation framework introduced in 2017. It is a wide-ranging consultation with an aim to have a legislative proposal by as soon as June 2025. Most market participants view this re-evaluation step as a positive sign for the asset class, given the relatively quick timeframe along with the renewed focus and recognition from the European Commission of the key place for securitisation as a funding tool.
• UK Auto Court Rulings: The Financial Conduct Authority (FCA) has been investigating the car finance sector for potential widespread abuse of Discretionary Commission Arrangements (DCAs) which were banned in 2021. Further complaints around commission arrangements outside DCAs, were upheld by the Court of Appeal in December 2024, which ruled that certain commissions paid to car dealers were unlawful. This ruling could expand the scope of the current investigation by the FCA and therefore scope for borrower redress. The ruling is being appealed by lenders and will be seen in the Supreme Court with further updates expected before Easter. These legal issues are creating a challenging environment for UK auto lenders, who must navigate increased regulatory scrutiny, potential financial liabilities, and market funding uncertainty. Please see our summary update on this here.

2025 Outlook

Floating rate products should continue to be an attractive proposition for investors given the relatively lower volatility compared to traditional fixed income products in a rate environment that continues to be volatile. Stability in asset performance within most asset classes should continue to underpin investor demand.

We see several themes in focus during 2025:

• Supply from less traditional sectors

Regarding supply, issuance for 2025 as likely to be generally in line or slightly higher than 2024, with some risks to the downside if macro or geopolitical volatility leads to a period of elevated spreads. Given inaugural deals in less traditional sectors in 2024 across European Solar ABS, UK Data Centre ABS and European Middle Market CLOs, we expect to see public securitisations prove to be a valuable alternative to the large levels of bank and non-bank lending already in place in these asset classes.

• Macro economic focus
  
  Economic indicators including unemployment rates, consumer affordability and corporate performance will remain a key focus during 2024.
   
  • UK economy
    • The UK economy ended 2024 on a pessimistic note where, despite lower interest rates, economic activity for the quarter was flat with several activity indicators turning negative and a generally poor reception from corporates to the first budget from the new government. Given the uncertainty around legislative redress for UK auto and consumer loan borrowers discussed above, origination and/or issuance in UK ABS may slow until there is more clarity seen.
  • Tariff impacts
    • Politics and policy impact are likely to dominate headlines, with European exports to the US in focus given President Trump's campaign proposals for tariffs across imports of goods. With exports to the US making up 20% of total European exports, this could have a material impact across European economies.
  • Politics and energy prices
    • Although some European economies have bounced back well post the covid pandemic and energy price shocks, with Spain being a good example, core European economies like France and Germany continue to record slow growth and are seeing increasing political disruption.

Despite the economic headwinds, we think that asset performance will generally hold up well, albeit with a stable deterioration likely in some sectors which may slow some of the positive rating migrations of ABS bonds seen across sectors over recent years.

2025 to start where 2024 left off

We expect 2025 to be another constructive year with high issuance volumes across European and Australian ABS. Our expectations are for asset performance to remain relatively stable as lower interest rates than recent peaks offset slow economic growth. However, we do expect there to be continued volatility in interest rates and for rates to remain higher for longer than market expectations.

ABS continues to benefit from a credit spread pickup to similarly rated corporate credit while the relative lower price volatility of floating rate ABS investments is often an under discussed advantage compared to traditional fixed income investments. The large and growing diverse range of investment profiles across ABS asset classes and jurisdictions continue to offer opportunity when taking a global relative value approach to portfolio construction and investment.

In this update, we present the quarterly State of Trend report for Q4, 2024. 

Our report covers the performance of Trend Following systems compared with traditional investments such as the S&P/ASX 200 Total Return index, and the Australia "60/40" portfolio. Trend Following provides exposure to a diverse pool of underlying instruments, and implements trading strategies systematically and without emotional biases.

Volatile market conditions prevail

Trend following systems offered mild positive performance in Q4 2024, ahead of traditional asset classes of stocks and bonds. Diversified asset exposure particularly across currencies and commodities (such as Bitcoin, Food & Fibre) helped stabilise returns over the period. 

Key market movements in Q4 2024

• Volatility resumed in Q4 2024

  • Equity and bond markets continued to whipsaw as markets weighed interest rate expectations, economic growth outlook, policy expectations post the US Federal election and escalating geopolitical issues

• However, commodities and currency markets saw trends extend

  • USD strength was the key theme for the quarter. Its Reserve Currency status was highlighted against all major currency pairs (including the AUD, EUR, JPY, KWY, NZD, BRL, etc), notwithstanding ongoing risks to the US economy and uncertainty around the impact of the change in US leadership

  • To the long-side, Bitcoin, some Food & Fiber contracts such as Cocoa, Coffee, Orange Juice and Palm Oil performed, along with Natural Gas. Others fell sharply, including Oats, Sugar and Cotton, along with Metals such as Platinum and Copper

• We remind investors of the power of a diversified portfolio when it comes to managing through uncertain market conditions - which can be accessed through Trend Following programs implementing the strategy across a wide pool of instruments across asset classes

Featured chart - AUD/USD

• Like other major currency pairs, the AUD de-rated materially against the USD through Q4 2024

• USD strength has been attributed to factors including:

  • reduced expectation for US rate cuts,

  • superior US economic growth compared to other jurisdictions,

  • increased potential pro-growth policies under the Trump administration,

  • Reserve currency amidst geopolitical machinations

• Trend following systems can rapidly reposition into trending markets, taking advantage of emerging dynamics as they occur

See the full report at our website.