Investment Ideas for Fixed Income Markets

March 2025

Addressing “Triffin’s Dilemma” is disruptive, but fundamentals remain sound for now…

Testifying before Congress in 1959 and 1960, Belgian-American economist Robert Triffin argued that there was a long-term crisis brewing for the country serving as host to the world’s reserve currency. In Triffin’s view, while the post-World War II Bretton Woods system that established the U.S. dollar, backed by gold, as the world’s reserve currency was an appropriate arrangement to get the economy back on its feet, it should have only been a temporary global currency framework. Importantly, what Triffin understood is that the world’s reserve currency is held by other nations as foreign exchange (FX) reserves to support international trade. And as the global economy continued growing there would be an insatiable natural demand for the reserve currency. To meet this voracious demand required the host of the reserve currency to run persistence trade deficits to make the arrangement work. Inevitably, the longer the trade imbalance persisted, the more severe the credit quality degradation of the reserve currency host over time would be. This paradox, known as “Triffin’s Dilemma,” exposed the inherent contradictions in a global system where one currency served as both a national and global reserve currency.

The flaws of the global financial system identified within Triffin’s Dilemma over 60 years ago has, among other considerations, driven the current U.S. debt-to-gross domestic product (GDP) profile to higher levels than seen coming out of World War II, which raises questions around sustainability. In terms of why this story matters now is that in analyzing Treasury Secretary Scott Bessent’s remarks at the Economic Club of New York on March 6, it appears that the Trump administration is seeking to address Triffin’s Dilemma as part of its ambitious agenda where Bessent noted, “The United States also provides reserve assets, serves as a consumer of first and last resort, and absorbs excess supply in the face of insufficient demand in other country’s [sic]domestic models. This system is not sustainable.”

Resilience in Fundamentals Despite Market Uncertainty

Radical change often represents uncertainty. Regime change to a system that largely has been in place for the past 80+ years exacerbates such concern. It is within this current environment of heightened uncertainty that the T. Rowe Price Fixed Income Division just finished its March Policy Week where one high-level key takeaway emerged. For right now, while dire headline risk has accelerated as the U.S. economy shows signs of slowing and equity volatility escalates, the underlying key fundamentals remain generally sound across most sectors in the view of our research analysts.

Credit spreads have widened in recent weeks but fundamentally remain generally supported. Many in the Fixed Income Division hold a broadly sanguine view on spread sectors if the economy remains strong enough to support demand for attractive absolute yields. Our sector specialists continue to weigh the risk and return trade-offs for credit sectors in the current environment as spreads remain historically compressed. Still, active security and sector selection should gain importance from here amid rising uncertainties.

Other Policy Week Highlights

One aspect of Policy Week is to identify concerns that our investment professionals have within the existing investment environment. Following increased volatility driven by higher-than-expected inflation data to start the year and significant policy shifts seen from the Trump administration, the largest concern coming out of Policy Week was around future growth. Growth concerns narrowly eclipsed inflation worries last month, but this month the gap between the two widened considerably.

While the U.S. economy has materially slowed, its longer-term growth trajectory remains positive for now. There is also divergence between the service and manufacturing sectors that drive the U.S. economy, with services growth trending below neutral while manufacturing activity has accelerated in recent months and now screens well above neutral. A point raised during Policy Week was that tariff uncertainty factors may be driving some of the recent strength in manufacturing as companies front-load shipments ahead of potential tariffs.

In China, weak economic data driven by continued struggles in the property sector and weakness in consumption activity appear to be stabilizing. This stabilization is now bolstered with fiscal support. Meanwhile, the eurozone saw a significant shift, with the U.S. signaling its intent to wind down its global defense spending, as Germany announced new economic policies that include around EUR 500 billion focused on defense spending. This additional spending could lead to a 20% rise in Germany’s debt-to-GDP ratio over a 10-year horizon. The scale of this policy shift is historic and has not been seen since German reunification late last century.

Domestic Inflation

The March 12 consumer price index (CPI) print surprised to the downside. Some of this deceleration represented a reversal of January’s elevated inflation trend. Overall, core CPI was up only 0.23% month over month and 3.1% year over year. Interestingly, shelter prices seem to be trending lower where nationwide property prices have not only stalled nationally but are retreating in popular housing market states such as Texas and Florida. Outside of shelter, most of the deceleration in services came from transport services and its volatile airfares component. Goods price pressures were broadly unchanged as a slowing in used car prices was offset by an uptick in other categories.

The Fed and 10-Year Rate Perspective

While the recent CPI print was benign and trended lower, the translation from core CPI to core personal consumption expenditures (PCE) counterintuitively points to a slightly firmer core PCE (the Fed’s preferred inflation measure) for February, which is one reason for the Fed to be cautious in cutting policy rates too soon from here. With the Fed’s existing policy rate being restrictive, our economist team still expects two Fed rate cuts in the second half of 2025.

And while future policy easing is anticipated, 10-year and longer-maturity U.S. rates are expected to rise from current levels as questions remain on who will buy the elevated U.S. Treasury supply that is expected to follow the eventual resolution of the U.S. debt ceiling. To this point, it was telling on March 12 when longer-maturity U.S. Treasury yields rose in the face of a benign inflation print. Our economics team expects a potential range of 4.00% to 4.50% or higher for 10-year U.S. Treasury yields in the near term but maintains a bias that yields could be materially above 4.50% beyond the next 12 months.

A Weaker U.S. Dollar

The narrative of the continuation of U.S. exceptionalism and strong domestic growth that this year opened with has reversed. Against the backdrop of slowing growth and increased uncertainty, the U.S. dollar has materially weakened since mid-January and has room to weaken further, in our view.

As an aside, from a theoretical perspective, if the Trump administration understands the holes in the global financial system that exist because of Triffin’s Dilemma, it is interesting to see the administration’s support in the cryptocurrency space. This connection is accompanied by a swift push for regulatory inclusion of cryptocurrency within financial infrastructure, including the banking system. These developments are being watched closely at T. Rowe Price by Blue Macellari and the digital assets strategy team she leads.

Bottom Line

Through a disciplined investment process, anchored by its Policy Week in conjunction with expanding quantitative capabilities and its ongoing global bottom-up research effort, the T. Rowe Price Fixed Income Division is qualified to actively manage the array of strategies that compose its investment platform through an investment environment that looks to be volatile in the months ahead.

February 2025

Alpha generation doesn’t occur by following consensus

Right now, the global economy is arguably growing just enough to avoid concern. China’s consumption economy continues to flounder, which negatively impacts Europe’s export-based economy. Emerging markets, meanwhile, offer a mixed bag from an economic perspective but are still proving to be resilient overall in the face of global uncertainty, which leaves the health of the world’s largest economy (the United States) as having heightened importance in the current environment. Fortunately, the U.S., driven by artificial intelligence tech-oriented and onshoring investment supported by aggressive fiscal policy, has proven to be “exceptional” when viewed on the global stage. This is good news as “favorable enough” global growth, anchored by the U.S., serves as a foundation for global equities despite the furious news flow and uncertainty that has accompanied President Trump’s second term in office.

While the current global growth story referenced above is good, it comes with an important disclaimer as it relates to the U.S. In recent years, and including last summer, there has been skepticism surrounding the durability of U.S. economic exceptionalism. With this said, the T. Rowe Price Fixed Income Division, based on fundamental research informed by our global fixed income and equity research platforms, has looked through the recent noise that has clouded the conversation around the health of the U.S. economy.

Skepticism and opportunities in global fixed income markets

Importantly, this conviction in U.S. economic resilience has allowed the platform overall to maintain a bias toward credit markets, which have performed well in recent years. This tailwind from solid credit performance, when combined with prudent duration management, can be supportive for fixed income investors. One phenomenon to note here is that the market’s reticence toward the U.S. economy amid significant noise can be viewed as an opportunity for our fixed income investment professionals to go against the “consensus grain.”

And while the T. Rowe Price economics team remains constructive on the U.S. economy coming out of the February Fixed Income Policy Week, the team has modestly lowered its conviction rating on the world’s leading economy for one primary reason, which is that market consensus now seems to overwhelmingly believe in the unrelenting strength of the U.S. economy. This consensus shift is helping drive spreads across risk sectors to historically tight levels. In other words, some parts of U.S. fixed income (and equity) markets are now “priced for perfection,” which leaves room for an active fixed income approach to question such unbridled enthusiasm.

Against this backdrop and an environment of stretched valuations, members of the T. Rowe Price Fixed Income platform are asking questions and prudently repositioning portfolios where warranted. Highlights from the division’s February Policy Week include:

U.S. inflation: The U.S. January inflation print released on February 12 was elevated with its 0.4% month-over-month and 3.3% year-over-year pace. While this inflation is alarming on its surface and for a market seeking affirmation that rate cuts may be coming, the owners equivalent rent (a primary factor in driving elevated inflation trends in recent years) has stabilized. Meanwhile, there may also be a “seasonal” element to the January data. Stay tuned as the Fed’s March Summary of Economic Projections and new “Dot Plot” will offer an opportunity to see through the concerning January inflation results.
Fed funds: With an economy growing north of 2%, an unemployment rate of 4.0%, and core personal consumption expenditures inflation in a range of the Fed’s target at 2.81%, the U.S. economy appears to represent a “Goldilocks” scenario for now. To maintain such a Goldilocks moment, monetary policy should be set toward the central bank’s neutral rate. In today’s less globalized world, neutral fed funds may be 3.75% or higher. Against this backdrop, our economics team expects the Fed to be on hold through the first half of 2025, but it still expects two 25 basis-point rate cuts before the end of this year.
An economic “sequencing” headwind may reinforce the need for two Fed rate cuts this year: While the U.S. economy remains resilient, its rate of growth is decelerating right now. And while the U.S. consumer story remains constructive, questions about the future rates of change in capital expenditures as well as fiscal spending have emerged. Consider fiscal spending in the U.S., for example, where the Trump administration is seeking to diminish the remaining life of Biden-led policies—such as the CHIPS and Science Act, the Inflation Reduction Act, and the Infrastructure Investment and Jobs Act—which will likely be replaced with Trump administration policies. The scale of such a transition may not be seamless, in our view.
U.S. 10-year yield: For right now, the U.S. 10-year Treasury yield appears rangebound in an approximate range of 4.40% to 4.80%. Future inflation trends will test this range in conjunction with Treasury supply. For now, U.S. deficits largely remain funded with Treasury bill issuance. Once a looming debt ceiling debate gets resolved in Washington, D.C., more coupon supply coming at a time of less foreign sponsorship for the asset class may also test this range.
Divergent monetary policy: While the Fed is on hold, our economists expect the European Central Bank to be aggressively cutting its policy rate in the months ahead. Meanwhile, the divergence between what is typically a closely connected policy rate in Canada and the U.S. is noteworthy. In addition, many emerging markets policymakers must consider potential currency volatility as they set monetary policy. For this reason, as well as the increasingly less globalized nature of today’s world landscape, many emerging markets policymakers are moving at a different cadence than the Fed.
Some good geopolitical news: A potential ceasefire between Russia and Ukraine appears to be rapidly forming. Meanwhile, after 15 months of military operations, Israel and Hamas have agreed on a ceasefire deal that was brokered and guaranteed by the United States, Qatar, and Egypt. The six-week truce on its own could provide a much-needed reprieve to the region and would also bolster regional credit stories in the surrounding area. Importantly, this market view and perspective is not intended in any way to discount the human tragedy involved with both of these catastrophic conflagrations.

Bottom line: Through a disciplined investment process, anchored by its Policy Week in conjunction with expanding quantitative capabilities and its ongoing global bottom-up research effort, T. Rowe Price Fixed Income is well positioned to actively manage the array of strategies that compose its investment platform through an investment environment that looks to be volatile in the months ahead.

January 2025

An Uneasy Equilibrium Drives Global Fixed Income Opportunity in 2025

In the wake of the January Policy Week for the T. Rowe Price Fixed Income Division and conflicting recent signals where a hot U.S. nonfarm payrolls number was quickly followed by a benign U.S. inflation print delivered on January 15, T. Rowe Price Chief U.S. Economist Blerina Uruçi summarized the complex current U.S. economic and rate narrative well with her following take:

“The U.S. economic situation is one of ‘Goldilocks’ where strong labor market data and a resilient U.S. economy consistently growing beyond 2% is not pushing inflation up (for now…). While a constructive and sustainable backdrop, this current U.S. economic state represents an uneasy equilibrium.

Consider that with a dramatic change in U.S. political leadership, there is now heightened near-term policy uncertainty. The specter of tariffs, for example, now raises upside risk to inflation while also introducing a headwind for growth. In addition, a fiscal package potentially stemming from the new administration’s critical ‘first 100 days’ is likely, at the margin, to be positive for growth while also contributing to an unwelcome tightening in the U.S. labor market.”

Beyond the near-term constructive but prospectively mixed backdrop described above is a rising general concern for the sustainability of developed world sovereign debt, which grew in scale as a byproduct of policy responses to the global pandemic. Through this lens, it should not be a surprise that global rates markets, led by the U.S., have become quick to materially react to any headline that has the potential to change the current narrative.

To this end, while the Federal Reserve (Fed) has cut its policy rate by 100 basis points (bps) since mid-September, the consistent story has been a reinforcement of U.S. economic resilience and sticky U.S. inflation. As a result, counterintuitively, the 10-year U.S. Treasury yield has risen by around 100 bps since mid-September as this note is being written. Interestingly, this storyline had the market beginning to price out any additional Fed rate cuts in 2025. This hawkish momentum then reversed with the January 15 consumer price index print. Ultimately, for right now, Ms. Uruçi believes that the Fed is on a path to cut its policy rate by 25 bps twice in the back half of this year. This would leave the Fed’s terminal rate—a rate that is neither restrictive nor constructive and reflective of a balanced economy—in the range of 3.75%, which, in a materially different and uncertain global setting, remains well above the central bank’s pre-pandemic preferred neutral rate of 2.5%. From this perspective, a prospective rate environment of not just higher for longer but just higher in general has gathered momentum.

Away from the U.S., the global economy, when adding up its various sovereign components, is also arguably in an uneasy equilibrium where growth is just strong enough to avoid recession. This additional story starts with the world’s second-largest economy, China. Here, thanks to a seismic residential property overhang that has paralyzed its consumer sector, China’s economic growth profile, which stands in the 4.5% range, is currently being driven by excess industrial production. As a result, China has served as an exporter of deflation to much of the rest of the world and Europe in particular. While welcome news for the post-pandemic global fight against inflation, manufacturing- and commodity-based economies such as Europe and Latin America have faced stiff growth headwinds. In contrast, countries in the Association of Southeast Asian Nations (ASEAN), such as Vietnam, Malaysia, and the Philippines, in addition to India and Japan, are economic beneficiaries of rising trade tension between China and the U.S.

Bottom line: Today’s asynchronous economic world is quite different from the one described over a decade ago by French economist Hélène Rey in her paper, “Dilemma not Trilemma: The Global Monetary Financial Cycle and Monetary Policy.” At that time, Ms. Rey argued that in a peak globalized world, the monetary policy of the U.S. was ultimately being exported—with the Fed also serving indirectly as a de facto global central bank—to the “periphery,” or the rest of the world.

Today, the world is different and becoming increasingly less globalized, which we believe has created a “moment” for global fixed income, where its asynchronous profile represents diversification and total return opportunities, when you consider that, while the Fed is now likely on hold until the back half of 2025:

The European Central Bank is likely to be aggressively easing its policy stance in the first half of this year;
Canadian monetary policy that historically has been tightly connected to the U.S. has meaningfully diverged;
Dynamic monetary policy in emerging markets in recent years appears materially more independent—recent monetary policy trends in Latin American countries such as Brazil and Chile speak to this phenomenon;
China, for now from a rate perspective, has begun to look like a current version of Japan’s initial deflationary experience during the 1990s; and
If China is exporting deflation to the rest of the world as it stretches excess industrial capacity limits to bolster its economy, a sovereign such as Türkiye with a 44% inflation rate (recently declining) warrants measured consideration. Türkiye is not only now making strides from a monetary policy orthodoxy perspective, but it also looks to be a geopolitical beneficiary of the collapse of the Assad regime in Syria.

Through a disciplined investment process, anchored by its Policy Week in conjunction with expanding quantitative capabilities and its ongoing global bottom-up research effort, we believe T. Rowe Price’s Fixed Income Division is uniquely qualified to actively manage the array of strategies that compose its investment platform through an investment environment that looks to be volatile in the months ahead.

Past investment ideas and themes

Exorbitant privilege and the U.S. presidential transition

December 2024

“It costs only a few cents for the (U.S.) Bureau of Engraving and Printing to produce a $100 bill, but other countries have to pony up $100 of actual goods in order to obtain one...” is how renowned American economist and author Barry Eichengreen once described the enormous benefit that the U.S. enjoys as the host of the world’s reserve currency. After all, as a direct result of the U.S. dollar’s (USD’s) role in the global financial system, America enjoys a lower cost of borrowing, a heightened ability to issue debt, and a platform that helps bring cheap international goods to its consumer base. In return, all who use the USD abroad benefit from using a currency that is supported by a country with a large and vibrant economy, a large and liquid sovereign bond market, liquidity support facilities, and a track record of stability backed by rule of law, which makes the USD an effective store of value for conducting global commerce.

Going forward, for the USD to maintain its preeminent currency role, ongoing sound macroeconomic policy and avoidance of overusing financial sanctions to achieve geopolitical objectives appear to be required. But it is on these two requirements where recent longer-term questions have begun to surface around the future of the USD, which include:

Fiscal discipline—Running fiscal deficits in the range of 7% of gross domestic product with an economy growing at about 2.5% while also having an unemployment rate around 4% runs counter to conventional Keynesian orthodoxy that calls for fiscal expansion to come predominantly in the face of economic weakness. This contradiction not only exists but could be stretched further next year with a possible extension of the 2017 Tax Cuts and Jobs Act. Through this lens, much will be riding on the new Trump administration’s Department of Government Efficiency as well as anticipated revenue from tariff policy to balance out a potential expansion of fiscal policy in the face of an already resilient U.S. economy. The world will be watching as events unfold on this front.
“Weaponization” of the USD—Since 2010, amid a general rise in global geopolitical tension, the U.S. has increased its use of sanctions to achieve geopolitical objectives, which has served as a catalyst for leaders of the BRICS alliance (Brazil, Russia, India, China, South Africa, Iran, Egypt, Ethiopia, and the United Arab Emirates) to propose the formation of their own common currency. And while this currency development appears to have a low probability of success, it is interesting to see President-elect Donald Trump recently threaten 100% tariffs on this bloc of nations if they continue in their efforts to disintermediate the USD.

The scenarios above represent just the beginning of numerous questions that await investors next year during a period of change in Washington, D.C., as the Trump administration will strive to reverse Biden policy wherever possible during its first 100 days, which is seen as a critical time period for a new administration to gain initiative. Closing the U.S. border on “Day 1,” in conjunction with an effort to conduct mass deportations, is just one of a series of Trump campaign promises that also include a concerted effort to pursue fossil fuels while also slowing the “green transition” that had been gaining momentum in recent years.

And while all the above represent areas for concern, markets, for now, appear to not only be wearing rose-colored glasses but also be focused on the present when considering:

U.S. monetary policy—Based on current data, the Fed appears set on normalizing monetary policy against a backdrop of full employment and inflation being within a range of their 2% target. To this end, if economic conditions are just right, the Fed’s next job is to find a neutral policy setting that is consistent with the current potential of the U.S. economy. Here, in contrast to the central bank’s pre-pandemic preferred neutral nominal rate of 2%, in a less globalized world, this policy target may now be in the range of 3.5%. But against a backdrop with so many future questions and a Fed that does not want to act too soon on easing policy too much, T. Rowe Price’s Economics team expects the Fed to deliver a 25-basis-point rate cut in December followed by two more 25-basis-point rate cuts before June 2025.

U.S. rates—Despite future uncertainty, the U.S. 10-year Treasury yield has rallied from the 4.45% range to 4.22% at the time of writing, largely based on benign recent inflation prints as well as anticipation of the prospective Fed rate cuts referenced above. What awaits next year is a likely increase in U.S. Treasury issuance that will need to be absorbed by a shrinking international institutional buyer base. To this end, while the Fed looks likely to be cutting rates through the first half of next year, rates further out the curve appear poised to move higher from current levels.

Away from the U.S. are other areas of concern—With a construct that demands fiscal discipline, certain eurozone countries are struggling to reduce their fiscal spending against a backdrop where their economies are suffering the effects of economic malaise that currently exists in China, among other considerations. As a result, governmental crises currently exist in France and Germany. And while it didn’t last long, martial law was declared in South Korea by President Yoon Suk Yeol on December 3 for the first time since 1980.

Bottom line: A time for active fixed income management—For now, markets appear to be focused on the potential benefits that may come with a second Trump administration that could deliver tax cuts, deregulation, and potentially heightened government efficiency while looking the other way on governmental tension and other concerns referenced above. War in Ukraine and questions about continued U.S. support for that country’s war effort, along with continued tension in the Middle East despite a near-term cease-fire between Israel and Hezbollah, also exist. Nevertheless, credit spreads across investment-grade and high yield markets reside near historically tight levels while volatility for the S&P, as measured by the VIX, appears historically benign at 13 points as this note is being written.

As was the case heading into last month’s U.S. presidential election, the T. Rowe Price Fixed Income Division is focusing on having general neutrality in respective strategies across the platform, supported by ample liquidity to navigate the uncertain weeks ahead. As we progress through next year, we believe the platform is poised to take advantage of what looks to be an exciting and fertile environment for active fixed income management. And away from this uncertainty remains the positive reality that global credit markets remain fundamentally and technically well supported, which could represent a strategic tailwind for fixed income investors.

Navigating global contradictions: a case for active fixed income management

October 2024

Keeping up with the market narratives of recent months has been a dizzying exercise. Consider, for example, that just two and a half months ago, many were convinced that the U.S. economy was headed for a deep recession. Today, market consensus has landed on the narrative that a “soft landing” has been achieved for the world’s largest economy just as elevated inflation fears of recent years have been presumably vanquished.

Balanced against such vacillating viewpoints is a reality understood by hedge fund manager George Soros. To Soros, market participants and policymakers can have a partial and distorted view of the world and then act based on these imperfect market views, which Soros calls “reflexivity.” This reflexivity can lead to market realities in near-term price action that can create opportunities for strategic and fundamentally focused fixed income managers, such as T. Rowe Price.

U.S. Economic Signals and Election Uncertainty

Right now, there is much to ponder amid global data points that don’t necessarily add up when one takes a step back from the current moment that exists in markets.

Consider the U.S., for example, where:

According to the JP Morgan Smoothed US GDP Nowcast, the U.S. economy is growing in the range of 2.5%. This level of growth appears sustainable for the foreseeable future, according to T. Rowe Price’s economics team.
The U.S. economy is arguably operating at full employment, with its seasonally adjusted unemployment rate currently at 4.1%.
And yet, with U.S. federal deficit spending projected to reach 7% to 9% of GDP for the next few years, the bond market appears to show little concern. The 10-year U.S. Treasury yield, near 5% a year ago, hovered just over 4% on October 15, 2024.
Interestingly, 10-year U.S. Treasury yields, while down from a year ago as referenced above, are up from the mid-3.6% range since the Federal Reserve cut rates in September.
In a hotly contested U.S. presidential election, markets appear to be ignoring the risks presented by the uncertainty that could be created by a far-from-smooth election outcome. Gold prices, meanwhile, currently well over USD 2,600 an ounce, may portend a different reality.

Room for Optimism

Away from the U.S., certain data points represent room for optimism for the global economy, while also being potentially perplexing for fixed income markets next year:

Recent stimulus from China, with potentially more to follow, appears to now be oriented on stabilizing cratering residential property prices in what ultimately appears as an effort to awaken a seemingly paralyzed consumption story in China. Slowing demand in China, which may have played into the easing shift for many central banks, now looks to potentially represent a different story next year.
With a possibly more constructive story in China, emerging market equities have performed well since early August amid an ebullient global equity market environment.
In contrast to the U.S., Brazil’s central bank began easing policy rates in August 2023, with its last rate cut in May 2024 to 10.5%. More recently, Brazil raised policy rates to 10.75% at its mid-September meeting this year.

Importantly, monetary cycles are much less synchronized across the world, which highlights the importance of a global economics and research team to understand and identify opportunities against the backdrop of diverging central bank policies. Through this careful analysis of divergent rate cycles around the globe, we believe that the T. Rowe Price Fixed Income Division can add value through a thoughtful active management approach.

Bottom Line – Heading into an uncertain election in the U.S. in conjunction with global data points that are seemingly contradictory, the T. Rowe Price Fixed Income Division is focusing on having ample liquidity to navigate the uncertain weeks ahead. Once the dust settles in the wake of the election, the platform is poised to take advantage of what looks to be a fertile environment for active fixed income management. And away from this uncertainty remains the positive reality that global credit markets seem to be fundamentally and technically well supported, which may represent a strategic tailwind.

All investments are subject to market risk, including the possible loss of principal. Fixed income securities are subject to credit risk, liquidity risk, call risk, and interest rate risk. As interest rates rise, bond prices generally fall. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates; differences in market structure and liquidity; as well as specific country, regional, and economic developments. Commodities are subject to increased risks such as higher price volatility and geopolitical and other risks.

Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2024, J.P. Morgan Chase & Co. All rights reserved.

Fixed income policy week takeaways

September 2024

The Fed and Other Global Highlights

In a move that many Wall Street economists missed in terms of scale, the Federal Reserve cut its policy rate by 50 basis points (bps) on September 18, its first ease in four years. Interestingly, according to John Authers of Bloomberg, in the wake of the Fed’s decision, when Fed Chair Powell was asked if not cutting in July was a mistake, he admitted that the Fed would in fact have moved then if it had access to June’s surprisingly benign inflation numbers that were published shortly after the central bank’s last meeting. Through this lens, Wednesday’s 50 bps move can be viewed as a “catch up” and not indicative of a Fed that just pulled an “economic fire alarm.”

In terms of what’s next, T. Rowe Price economist Blerina Uruci, who had projected the Fed cutting 50 bps this week, expects two more 25 bps moves from the Fed before year-end. In aggregate, she expects the Fed to cut 125 bps to 150 bps over the next 12 months in 25 bp increments, which stands in contrast to the market that is looking for approximately 250 bps in total cuts over the same time horizon.

So far, U.S. equity markets have welcomed this Fed action and guidance that came with it as the S&P 500 advanced following the Fed rate cut. However, the U.S. Treasury yield curve, which had already rallied sharply since last April, has shrugged off the news. Consider the 10-year U.S. Treasury yield, which notably rallied since late April to September 16 but trended higher during the week of the Fed meeting. This seeming U.S. Treasury yield curve indifference is consistent with the beliefs of the firm’s Fixed Income Division, which expects the reaction function in intermediate- to long-maturity U.S. Treasuries to this Fed easing cycle to be unique relative to history. In other words, it may be that the U.S. Treasury yield curve returns to its more normal positive slope across its term structure by having intermediate to longer maturities remain at current to higher levels as the Fed sets forth on the easing path described above. Supportive of this view is the understanding that this Fed cut is proactive relative to a softening U.S. labor market but not reactive to a broken U.S. economy. In addition, the team is also cognizant that the market will need to absorb considerable U.S. Treasury coupon supply next year to support U.S. deficit spending and fiscal policy largesse while also being mindful of shifting global macroeconomics.

Global Economic Considerations

Away from the U.S., eurozone policymakers face a quandary as services inflation is running beyond target while the central bank has begun an easing campaign to address weakness in its manufacturing sector that arguably ties into economic malaise in China. With regard to China’s economy, economic data, driven by a collapse in China’s residential property sector, continue to disappoint. Income, consumption, and construction all continue to soften, while policy continues to respond with incremental steps seemingly intended to prevent a larger drawdown in its struggling economy. An additional observation of interest comes from Latin America, which reinforces the conservative viewpoints on where our Fixed Income Division expects domestic rates to go from here, articulated above. To this end, it is interesting to note that Brazil’s central bank, which has been running almost a year ahead of the Fed throughout the post-pandemic global rate cycle, just raised its policy rate 25 bps to 10.75% after cutting this same rate from its recent peak of 13.75%.

Bottom Line—From our perspective, T. Rowe Price offers a full suite of fixed income products for investors looking to move out of cash and into short duration credit or intermediate/core and global multi-sector fixed income. Meanwhile, the absolute yields now offered by domestic and global high yield, which are now also economically supported by the Fed, warrant strong consideration in our view.

Through a disciplined investment process, anchored by its policy week in conjunction with expanding quantitative capabilities and its ongoing global bottom-up research effort, the T. Rowe Price Fixed Income Division is qualified to actively manage the array of strategies that compose its investment platform through an investment environment that looks to be volatile in the weeks and months ahead.

Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments.

Sahm, Sahm but different: Why the breach of the Sahm rule doesn't mean the U.S. is in recession

August 2024

T. Rowe Price expects the US Federal Reserve (Fed) to begin cutting policy rates with a “base case” that such action begins in May 24. How many cuts remains open to question as a significant easing of financial conditions late last year, a seismic wave of developed world sovereign supply soon coming to market and the disruption of oil supply in the Red Sea complicate the Fed’s mission of maintaining full employment at a level that is consistent with ongoing price stability.

Nevertheless, the Firm’s fixed income division expects at least three rate cuts this year with as many as six cuts or more, some potentially in 50 bps increments, before the US autumn with the US Presidential election looming later this year.

Soft landing?

With the domestic unemployment rate residing at less than 4%, while Core Personal Consumption Expenditures (PCE) inflation hovers in real time near the Fed’s target of 2% (see below), the premise that the US economy is currently experiencing a “soft landing” economic outcome was acknowledged. But before celebrating the Fed on a job well done, as they have been able to bring sharply elevated pandemic policy induced inflation to heel without triggering a recession, the realisation that today’s benign economic outcome is not a destination, but instead is a tenuous moment within a cycle was also discussed.

If the most real time inflation trends in Core PCE are indeed able to remain in the range of the Fed’s preferred inflation target, then a strong argument can be made that current domestic monetary policy is far too restrictive. In other words, the current “soft landing” state of the US economy can only endure with help from the Fed as the economy and inflation have arguably reached pivotal post pandemic points of inflection.

Inflection point

Identifying points of inflection from recent trends are important as they reveal a future that is certain to be unique relative to the recent past. Today, as referenced above, this consideration matters greatly with regard to inflation. With the economic and inflation “distortions” that followed the world’s US$25 trillion policy response to the pandemic largely gone, the reemergence of the importance of the Fed’s preferred measure of inflation—Core PCE that excludes food and energy—has arrived just as (referenced above) the 6-month annualised rate for this inflation gauge hovers in the Fed’s target range of 2%. In addition, even though inflation remains broadly elevated relative to pre-pandemic levels; as reported by Bloomberg on 11 December 2023, inflation views among Americans over 60 years old have retreated to a three-year low. As a result, inflation, both from quantitative and qualitative perception perspectives, is closer to where the Fed wants it to be than is generally perceived, which has implications for domestic monetary policy.

Two key foundations of pre-pandemic US monetary policy included a Core PCE Inflation target of 2% and an r* (an equilibrium or neutral policy rate that is neither restrictive nor accommodative) of 2.5%. And while much has changed since late 2019 in terms of deglobalisation trends and more uncertain geopolitics, which imply that these pivotal foundations now need to be adjusted upward; in a world that has largely normalised from pandemic policy distortions, Core PCE and an idea of where a neutral r* Fed Funds rate should be remain key to understanding where Fed policy goes from here.

Connecting these dots

If the Fed’s targeted policy rate is 2.5% (at the time of writing it hasn’t changed…), then the Fed’s preferred “real” r* neutral rate is 0.5%. Now consider where “real” current Fed policy rests with “real” Fed Funds now hovering in the range of 3.25% to 3.5% relative to a target of 0.5%. Through this lens, even if there are some changes to the notion of what the r* neutral rate should be, as referenced above, the Fed now has more significant room to cut rates. Said a different way, the current “soft landing” profile of the US economy is not sustainable with “real” monetary policy so restrictive. and this argument does not even consider Quantitative Tightening, which continues in the background. The math discussed above is illustrated below:

The Sahm recession indicator (the Sahm rule), one of the most accurate leading indicators of every U.S. recession since the early 1970s, had already been trending in recent months and became a market focus after the most recent non-farm payrolls data release. While breaching the Sahm rule, based on history, can be interpreted to mean that the U.S. economy is nearing or already entered recession, the T. Rowe Price Fixed Income Division thinks this time is different. Here’s why.

What is the Sahm rule?

The Sahm recession indicator signals the start of a recession when the three-month moving average of the national unemployment rate (UR) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months.

The details of the July breach tell a different story

While this value of 50 basis points (bps) was met with the July data when the UR rose to 4.3%, there are some reasons that support that this may not mean that the U.S. is entering or has entered recession, such as:

The details of the July labour report suggest that the labour market is not as soft as suggested by the headline numbers. In particular, the UR increase was mainly driven by a rise in labour force participation, an increase in the number of people that were not able to work due to bad weather, and rising temporary layoffs, with the caveat that those individuals could be called back into work over the next few months. Permanent layoffs, meanwhile, remained modest.
Importantly, the National Bureau of Economic Research (NBER) is the final arbiter on whether the U.S. economy has entered an economic recession. The NBER evaluates a range of indicators, including real disposable income growth, real consumer spending, industrial production, and the unemployment rate, which all moved in the same direction prior to the last three recessions that occurred after a triggering of the Sahm rule. In contrast to this historical analysis, during the past three months, only household employment data has been soft, while the other indicators remained expansionary.
While this time may be different for a breach of the Sahm rule, it didn’t prevent markets from fiercely overreacting, in our view, when this negative data point for the world’s primary economy almost immediately followed the Bank of Japan’s historic 25 bps policy hike on 31 July 2024. As a result, August’s generally illiquid summer market had to immediately grapple with the synchronous prospect of higher policy rates in Japan and potentially sharply lower policy rates in the U.S. (materially driving both currencies forcefully in different directions), which, in combination, represented a form of a margin call for a yen carry trade that had grown in seismic scale since the end of 2022. Interestingly, while this global capital market tumult followed the triggering of the Sahm rule, when much of the yen carry trade quickly unwound, capital markets have not only largely stabilised but also have mostly recovered what was lost during this recent market shock.

Fed rate cuts could lend support

Beyond the Sahm rule, we also recognise that recent decelerating trends in inflation and employment growth have also opened the door for the US Federal Reserve (Fed) to start easing monetary policy (helping extend the economic cycle), but just not at as fast a pace as the market quickly priced, which was part of the phenomenon that sparked the global carry trade unwind referenced above.

T. Rowe Price’s Chief U.S. Economist Blerina Uruci currently expects up to three rate cuts from the Fed before year-end if inflation and labour markets continue to cool. To the extent that this view matches prospective Fed action, the current state of the economy and markets appear to be in a mid-cycle adjustment where the Fed may cut rates in 25 bps point increments four to five times in aggregate (including the three rate cuts mentioned above). Such a move would help extend the fundamentally sound condition of the U.S. economy, which remains resilient in our view.

Bottom line

While the technical catalysts that drove the sharp capital market unrest described above look to have now largely played themselves out, additional volatility, driven by other considerations such as geopolitical and U.S. election uncertainty, appears likely in autumn. There is a silver lining, however, as increased volatility helps make a case for active management in fixed income from the following three perspectives:

A normalising U.S. Treasury yield curve – While the normal shape of the U.S. Treasury yield curve is upward sloping as it appropriately discounts the time value of money, the U.S. Treasury yield curve has been far from normal and inverted since July 2022. With the Fed now in play for September and driving yields down in the front end of the Treasury yield curve in the process, “curve steepening” strategies represent an opportunity for active fixed income managers to position ahead of a return to a normally shaped U.S. Treasury yield curve.
A resilient U.S. economy is supportive of credit – While spreads remain historically tight across the quality spectrum, credit fundamentals that have been sound appear poised to remain so in our view. More importantly, credit markets remained open during the recent market distress, which signals a diminished probability that hidden technical pressures exist across global credit markets.
U.S. Treasury yields plunged during last week’s market upheaval – Increased market volatility and dramatic swings in U.S. Treasury yields can create opportunities for fixed income managers who can tactically adjust duration exposures. T. Rowe Price Fixed Income Teams took the opportunity to shorten duration in select strategies when the 10-year U.S. Treasury yield overshot (in our view) downward to the 3.7% range—now closer to 3.9% as of 12 August—particularly relative to heavy U.S. Treasury supply still to come.

From a more holistic perspective, meanwhile, the move out of cash and into short duration—the T. Rowe Price team has been presciently long duration within the front end of the yield curve— now warrants additional consideration with the next Fed communications coming in the form of a “live” September meeting. Beyond a small step into short duration, the next larger move into intermediate/core fixed (as well as global fixed income) becomes a light at the end of the tunnel that suddenly approaches with a now quickly normalising Treasury yield curve.

Through a disciplined investment process in conjunction with expanding quantitative capabilities and its ongoing global bottom-up research effort, the T. Rowe Price Fixed Income Division is qualified to actively manage through an investment environment that looks to be volatile in the weeks and months ahead.

Rate cuts could come sooner than you think

July 2024

The T. Rowe Price Fixed Income team expects the Federal Reserve (‘Fed’) to deliver a 25-basis point (bps) rate cut at its September meeting, with the probability rising for more easing before year-end. Amid a myriad of variables evaluated to assess potential future Fed action, recent favourable trends in ‘sticky’ and elevated Owners’ Equivalent Rent (OER) as well as transportation costs (airfare, hotel prices, and used cars) emerged as key drivers for falling inflation. Decelerating wage pressure in recent months (see Fig. 1), combined with a slower-growing US economy, also opens the door to a rate cut in September, in our view.

The resilient yet softening US economy

The US economy is bent from the US Federal Reserve’s (‘Fed’) higher for longer monetary policy, but it’s not broken. The once ‘white hot’ housing market during the pandemic has slowed under the weight of 7% mortgage rates. Importantly, this helps reduce the sharply elevated OER, one of the most important components embedded within domestic inflation levels today. Beyond decelerating OER, a strong domestic labour market is now also showing signs of softening, evidenced by slowing wages.

Against this backdrop, the Fed’s preferred inflation gauge, Personal Consumption Expenditure (PCE), reached 2.6% in its May release. These considerations, along with anticipation of a US economy growing in the 1.5% range (per the JP Morgan Smoothed US GDP Nowcast) instead of its 3% pace a year ago, again put the Fed in a position to act in September from our perspective.

Fig 1 US inflation relative to OER and wage growth

Source: Bloomberg Finance, L.P. May 2024.

The uncertain path ahead

While inflation is moving in the right direction, its future remains uncertain. Between a trade war started in 2016, the pandemic, and heightened geopolitical uncertainty, today’s world is less globalised and arguably more inflationary than the one left in late 2019. With pandemic-related distortions finally working their way out of the financial system, global fragmentation concerns now arguably become more important.

Consider the deflationary trend in core good prices during the past year, which we now see as a contributor to inflation going forward. Interestingly, we also see the most recent fall in airline fares and hotel prices as one-off contributors to deflation. More importantly, the acknowledgment that the sharp recent drop in OER, which ties into a softer US housing market, appears likely to either fall at a decelerating pace or stabilise from here as overall housing supply scarcity remains a price support for the sector overall.

A measured view on future Fed action

In light of the balanced perspective referenced above, T. Rowe Price Fixed Income team maintains a more measured view on future Fed action compared to the market, which now expects approximately seven rate cuts from the Fed over the next four to five quarters. For now, we expect a 25-bps rate cut from the Fed in September while acknowledging a growing probability that more Fed action may follow before year-end.

Strategic focus amid rate cuts

Through the lens described above, the T. Rowe Price Fixed Income team is focused on portions of the market that we believe offer convexity (such as select securitised credit), which can participate in market upside while importantly limiting the downside of higher rates; a risk that is largely being ignored by the market at this time. At the strategy level, with the Fed now poised to move, we believe short-duration strategies take on heightened importance while emerging market debt looks to benefit from a less strong US dollar that, in our view, looks to weaken near term with Fed action coming. With the exception of some near-term weakness in select regions within emerging market debt, we believe credit markets and related strategies remain wide open overall.

Bottom line

Through our disciplined investment process, in conjunction with expanding quantitative capabilities and our ongoing global bottom-up research effort, the T. Rowe Price Fixed Income team is uniquely qualified to actively manage an array of strategies through an investment environment that we believe will be volatile in the weeks and months ahead.

Aggressive fiscal policy and an AI "arms race"

June 2024

Powered by aggressive fiscal policy and an AI "arms race" driving elevated capex spending, a resilient US continues to drive the global economy but now has some help from Europe. With an industrial oriented economy that never fully recovered from the economic impact of the pandemic, Europe is now experiencing not only a near term pickup in manufacturing momentum but is also achieving recovery within its services sector. And while China has experienced an epic property collapse that has weighed on its consumer base, it has also shifted its economic focus toward industrial production and is flooding the global economy with cheap exports such as electric vehicles and solar panels in the process. As a result, China doesn’t represent a drag on global growth, but, importantly, has represented a deflationary pulse that has helped ease inflationary pressures more globally.

Against this backdrop, the following highlights emerged:

Overall Global Growth – Relative to a scale that evaluates markets and issuers at a most constructive level of 1 to a nadir of 5, our Fixed Income division sees the global economy operating at a level of “2” into the Australian spring.
Inflation and the US Federal Reserve – Inflation in the US remains elevated, sticky but is still gradually moving in the right direction as Core CPI is expected to decrease from its current level of 3.4% to the 2.8% range by next Australian Autumn. And while still elevated, US monetary policy, at its current level, is still restrictive and the Fed does not want to induce a recession by being late to ease. Against this backdrop, the T. Rowe Price Fixed Income division expects one 25 basis points cut from the Fed before year end which is aligned with current Fed guidance while other market participants expect as many as 300 basis points of cuts by next Australian Autumn.
Risk assets remain supported – The macroeconomic landscape described above remains constructive for risk assets. And with a connection to vibrant private credit markets as well as a price discount that bolsters an already attractive “surface” yield for the asset class, Bank Loans remain a high conviction sector for the division. Based on valuation as well as potential diversification benefits they provide, the Securitised sector and higher quality portions of Collateralised Loan Obligations also represent heightened value.

Sovereign risk and a wide near-term range for US Yields

James Carville, a political adviser to the Clinton administration, once quipped that if there was reincarnation, he aspired to come back as the bond market so he could intimidate everybody. Carville was of course referring to so-called bond market vigilantes who sell the bonds of fiscally irresponsible sovereigns to drive up their yields as a stratagem to alter their behavior. And while bond market vigilantes haven’t been heard from much since the 1990’s, they have emerged in recent years as a force to consider.

Former British Prime Minister painfully found out about such vigilantes in the fall of 2022 when they arguably forced her out of office in just 44 days after Liz Truss put forth a disastrous “mini budget” that spooked markets and drove yields up while also negatively impacting the Pound. Similar dynamics are taking place in France right now as President Macron’s snap election has roiled France’s bond market as strong showings from far right and left wing parties have exacerbated general concerns for fiscal sustainability in France.

For right now, with the exception of certain moments last fall, the US has generally been immune to such negative action in its Treasury market despite its burgeoning national debt and wide annual deficits. And while this largely stems from the US hosting the world’s reserve currency in addition to boasting a bond market that is hard to replicate in terms of its scale and ease of use, the sobering reality that fiscal prudence will not likely be returning to the US anytime soon is one reason why T. Rowe Price Fixed Income division expects the 10 Year US Treasury to trade within a range of 4.00% to potentially 4.75% for the foreseeable future even with a potential Fed rate cut this year.

Additional Disclosures
Unless otherwise stated, all information is sourced from Bloomberg Finance L.P., as at 31 May 2024.

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