Why Bonds Still Look Attractive in a Volatile World

By Paul Saint-Pasteur, Director, Global Fixed Income Strategist, Payden & Rygel

In a year defined by geopolitical shocks, shifting growth expectations, and persistent inflation risks, it is natural for investors to question what comes next for global bond markets. Yet, despite the headlines, our base case for the global economy remains broadly intact: we still expect global growth to run close to trend over the next 12 months, even though the range of potential outcomes has widened.

A wider range of economic outcomes

Recent geopolitical developments have led us to modestly trim our growth expectations and assign a higher probability to scenarios in which inflation proves stickier than previously assumed. In practical terms, that means we are somewhat less confident about the precise path of growth and inflation, but we are not markedly more pessimistic about the overall trajectory. The United States, supported by AI-driven investment and gradually normalizing inflation, still appears to be on a reasonably solid footing, while more energy-sensitive regions such as Europe and the UK face a more challenging outlook.

Why the backdrop still favors bonds

Against this backdrop, we remain firmly in the camp that sees this as an attractive environment for fixed-income investors. Over the short term, volatility and headline risk will continue to create uncertainty, and no one has an edge in predicting how geopolitical events in places like the Middle East will evolve over the next few weeks. Over a medium- to longer-term horizon, however, the story looks very different: starting yields are higher and bonds can once again deliver healthy income through carry. Investors no longer have to rely solely on falling yields and capital appreciation to generate total returns.

Why active management matters more now

In our view, this is not a market where you want to be purely “beta-driven”. Persistent geopolitical risk, tighter valuations, and the potential for slower growth all argue for a more selective, active approach to fixed income. Regional and sector divergences are becoming more pronounced, and that creates opportunities for investors who are willing to look beyond broad benchmarks and think carefully about where they allocate risk.

Positioning for income and resilience

In terms of positioning, we currently favor high‑quality core bonds and shorter‑maturity strategies. High‑quality core exposure can play a dual role: providing income today and helping to protect broader portfolios if growth slows more than expected. Shorter‑dated bonds offer attractive carry with the potential for additional capital appreciation if the rise in yields we have seen this year were to reverse. Credit markets continue to offer potential for excess returns, but we believe investors need to be selective across both sectors and regions.

Where we are cautious

There are also parts of the market we are deliberately avoiding. We remain cautious on the longer end of the yield curve, where we believe fiscal risks are still underappreciated. In addition, we are wary of lower‑quality issuers and sectors undergoing significant structural change, especially those facing potential disintermediation from AI and other technologies. In an environment characterized by higher rates, greater dispersion, and persistent volatility, we expect clear winners and losers, and security selection is likely to be a key differentiator.

The case for emerging markets

Emerging markets stand out as a particularly interesting opportunity set. In aggregate, many EM countries offer high nominal and real yields, solid fundamentals, and in some cases a degree of insulation from higher energy prices, or even a benefit from them. Local‑currency EM debt, in particular, can provide diversification benefits relative to traditional developed‑market exposures, while still offering attractive income.

Why now may be the time to move cash off the sidelines

The question many investors are asking is whether now is a good time to move cash off the sidelines. Our answer is yes, provided investors adopt a medium‑term horizon. Over the next four to six weeks, the next 50 basis point move in yields could easily be up or down, and we do not believe anyone can forecast that path with precision. Over the next few years, however, today’s elevated yields present an appealing entry point for investors seeking income and diversification.

Restoring bonds’ diversification role

Some observers have argued that bonds are “behaving like stocks,” pointing to the recent period of positive correlation between the two asset classes. This dynamic is not new, we saw a similar pattern in 2022, when rising yields driven by inflation concerns reduced the diversification benefits of fixed income. Over the prior decade, though, bonds were a very effective diversifier, typically exhibiting a negative correlation with risk assets. Our view is that as inflation concerns eventually moderate and geopolitical uncertainty stabilizes, the stock‑bond relationship is likely to revert toward a more traditional pattern, restoring fixed income’s role as a diversifier in multi‑asset portfolios.

Portfolio construction in a higher-for-longer world

The “higher for longer” interest rate environment also has important implications for how portfolios should be constructed. With yields elevated and dispersion across issuers and sectors increasing, we expect fixed income returns to be driven more by income and security selection than by broad duration rallies. For us, that translates into three pillars for portfolio construction today: generating attractive income, maintaining sufficient diversification to capture regional and sector divergences, and preserving capital in the face of ongoing volatility.

Some fixed-income investors have described this as the best opportunity in a decade for income. We share the view that this is a very attractive environment for bond investors. Elevated yields, the potential for productivity gains, particularly in economies like the US, where AI and innovation may support growth, and the likelihood of inflation concerns easing over the longer run all point to a constructive outlook for the asset class. While it is always difficult to predict exactly how any single year will unfold, we believe the global bond universe offers a rich opportunity set for active managers capable of exploiting the divergences that are now emerging.

This material reflects the firm’s current opinion and is subject to change without notice. Sources for the material contained herein are deemed reliable but cannot be guaranteed. This material is for illustrative purposes only and does not constitute investment advice or an offer to sell or buy any security. Past performance is no guarantee of future results.
This material has been approved by Payden & Rygel Global Limited, a company authorised and regulated by the Financial Conduct Authority of the United Kingdom, and by Payden Global SIM S.p.A., an investment firm authorised and regulated by Italy’s CONSOB.