Introduction to the Bond Market
The global economy has shown its strength as central banks have reduced interest rates, and further reductions may follow. This creates an interesting landscape for bonds going forward. Selectivity and care may be critical in determining where to take duration risk and how to think about carry, rather than spread compression, as a way to generate returns.
Government Bonds: Overweight in Duration
Gareth Isaac, Head of Global Multi Sector, maintains an overweight position in duration, primarily concentrated in the UK front end. The current UK government may struggle to reassure bond markets, but the Bank of England is expected to ease policy more aggressively than currently priced. Short-term interest rates may fall more quickly than long-term rates, so there is a curve steepening bias, preferring exposure at the very short end of the curve.
UK Government Bonds
The Bank of England had been unexpectedly reticent to cut in the face of a weak growth outlook, but recent moderation in wage growth and controllable inflation suggests a shift toward a more accommodative stance is imminent. The base case anticipates that the Federal Reserve will lower rates sharply in response to softer economic conditions but could subsequently reverse course should the US economy rebound quickly.
Emerging Market Local Debt
The Invesco fixed income team remains constructive on local rates in select emerging markets, supported by expectations of a weaker USD and growing investor appetite for diversification amid rising developed market bond supply. Many emerging market central banks retain policy flexibility, with room to ease rates as inflation moderates, enhancing the attractiveness of local bonds.
Emerging Market Local Debt: Strong Reasons to Invest
Wim Vandenhoeck, Co-Head of Emerging Markets Debt, is positive on emerging market local currency sovereign bonds. Inflation overall has been well managed by orthodox monetary policy, highlighting the improvement in institutional credibility, and inflation continues to moderate. As a result, most emerging market central banks have room to ease interest rates from elevated levels, enhancing the attractiveness of local bonds.
Valuations and Performance
In terms of valuations, all-in yields remain attractive despite recent strong performance, with the potential of further capital upside as central banks ease policy. This, combined with the expectation of a weaker US dollar, has seen flows into the asset class create a positive technical bid. Flows should continue as global investor exposure to emerging market assets remains modest, especially in local bonds.
UK, Europe, Global Investment Grade Credit: Tight Spreads and Minimal Credit Risk
Michael Matthews, Co-Head of Business Strategies, IFI Europe, notes that credit markets have performed well again in 2025. Spreads recovered quickly from the ‘Liberation Day’ weakness and have squeezed consistently tighter since the spring. Credit markets are supported by the stable macroeconomic backdrop and improved financial conditions following interest rate cuts from the European Central Bank, the Bank of England, and now the US Federal Reserve.
Challenges and Opportunities
The challenge for credit market investors is that spreads are now close to, or at, their all-time tights. As a result, returns will likely be carry-based for the foreseeable future. There’s little variation in credit spread between sectors. The general approach has been to trim exposure to weaker-rated credits and tilt the portfolios to higher-rated and more liquid issuers where the give-up in spread is relatively modest.
High Yield Credit: Stable Lending Standards and Improving Credit Quality
Thomas Moore, Co-head of IFI Europe, notes that high yield corporates, and subordinated regulatory bank debt in particular, have performed well in 2025. Spreads have tightened, adding capital gain to the carry. Supported by strong investor demand, supply of high yield has risen for the fourth consecutive year. In Europe, for example, gross supply is on track for its second-strongest calendar year in more than a decade with more than 200 new bonds issued.
Risks and Opportunities
Despite the strong backdrop, the market isn’t without its risks. Whilst the core and stronger parts of the market have performed well, weaker credits have struggled for a mix of company-specific and sector-based reasons. A good example is chemicals, a sector in which many issuers are struggling under the weight of surging supply from China and weak demand from key industry customers such as autos and housing.
ETF Investment Teams: Net Inflows Setting Records
Paul Syms, EMEA ETF Head of FI & Commodity, notes that net inflows into fixed income UCITS ETFs proceeded at record pace in 2025. The $62 billion raised through October falls just $6 billion shy of 2023’s total for the year. Assets under management for European-domiciled fixed income ETFs recently broke $600 billion. Fees on traditional exposures have become increasingly competitive with a wider choice of ETFs available.
Conclusion
In conclusion, the bond market is expected to be shaped by central bank policies and economic conditions. Selectivity and care are critical in determining where to take duration risk and how to think about carry. Emerging market local debt and high yield credit offer strong reasons to invest, while government bonds and investment grade credit require careful consideration of spreads and credit risk. As the market continues to evolve, it is essential to stay informed and adapt to changing conditions to maximize returns.
