Optimising fixed income allocations in a new market regime

The post-QE fixed-income regime favours shorter-duration and specialist credit strategies because long-duration government bonds and mainstream corporate credit offer inadequate risk compensation and weaker diversification.

• Since 2022, central banks have ended ultra-low-rate policies and QE, while markets are pricing 50 to 75 basis points of further hikes over the next 9 to 12 months for most Western central banks.
• Shorter-duration strategies should limit price sensitivity if these hikes occur, pass higher carry through more quickly, and generally remain less correlated with equities and commodities than longer-duration strategies.
• Longer-dated government yields are near multi-decade highs, but fiscal and credit pressures, reduced foreign participation, competing issuance, deglobalisation and possible political influence on central banks could push real short-term rates and term premia higher.
• Global high-yield bonds trade at only 270 basis points over governments, whereas comparisons with default rates, economic conditions and VIX indicate spreads closer to 450 basis points; mainstream corporate credit is therefore expensive relative to its risks.
• In US investment-grade corporate bonds, Treasuries account for 85% of yield and credit spreads only 15%, while correlations with Treasuries have reached 0.96 for investment grade and 0.78 for high yield.

Takeaway: Investors should avoid materially extending duration beyond five-year maturities and question mainstream corporate credit, instead seeking specialist fixed-income solutions with contained rate risk, better-valued spreads and stronger diversification, while recognising that the outlook depends on inflation, fiscal supply and central-bank policy.