A bond market built for active management

What opportunities am I seeing in the US? It’s been a challenging few months for fixed-income investors. Rising Treasury yields have led to lower bond prices and negative returns. But here’s the good news. We think the risk/reward in bownds looks much more favorable from here. We always remind investors that while rising bond yields can be painful in the short term, they can set the stage for better future returns.

Now, we would like to see inflation come down and energy prices ease. But at these higher yield levels, investors are earning more income and have a much bigger cushion against further rate increases. In addition, Treasuries and high-quality bonds can provide meaningful protection against a sell-off in risk assets. And we saw this recently as equity markets came under pressure due to concerns around AI valuations. Bonds once again played their traditional role as a safe haven, and we think they can continue to do that going forward. And that remains an important part of the case for bonds today.

When we look across the US bond market, where are we seeing opportunities? One area is agency mortgage-backed securities. What’s interesting about the housing market is how much higher interest rates have changed the supply and demand dynamics. The average homeowner with a mortgage is paying around 4% versus more than 7% for a new mortgage today. With more than 95% of borrowers locked into rates below the current market, there’s a powerful incentive for homeowners to stay put rather than give up that low-cost financing.

As a result, housing turnover has slowed significantly, which in turn has reduced the supply of new mortgage-backed securities. We expect only about $100 billion in net MBS supply in 2026, compared with more than $600 billion in 2020 during COVID, and with expectations for more than $1 trillion in net corporate bond debt this year.

Another area we like is CLOs. These securities are backed by diversified pools of corporate loans and, importantly, have floating interest rates. That means investors can earn attractive income with much less sensitivity to rising Treasury yields. We see good opportunity in the highest-rated parts of the market – AAA and AA rated tranches – where significant structural credit protection and diversification helps limit credit risk.

We’re also starting to see idiosyncratic opportunities in technology and AI within investment-grade corporates. There’s been growing dispersion in the IG corporate bond market this year. At the index level, spreads are only modestly wider, but that masks very different performance beneath the surface. Energy and commodity-related sectors have performed well, while areas tied to AI have come under pressure from heavy new issuance to fund AI investment. We’re seeing a similar dynamic in the data center market, where some data center bonds are trading at wider spreads than the companies that ultimately support those facilities. For us, that dispersion is starting to create select opportunities to buy high-quality credits at valuations we think are attractive.

One of the things that’s been notable this year is how resilient emerging markets have been during the recent rise in US interest rates. That’s a real departure from what we’ve seen in past cycles. We think that speaks to a strong global economy, better country fundamentals, and more credible monetary policies in central banks.

On the corporate side, we see opportunity in commodity and energy-related companies where investors can pick up additional spread relative to similarly rated US corporate bonds. On the local currency side, we see opportunities in sovereign bonds offering attractive real yields.