Key Drivers of Bond Performance in 2025

The cost of funding for a AA-rated U.S. bank is closely linked to prevailing short-term interest rates and the bank’s specific funding mix. As of early 2025, average cost of funding (COF) for banks has plateaued, with recent industry averages ranging from about 2.5% to 3.5% depending on the size and structure of the institution. AA-rated banks, given their strong credit quality, typically secure funding at the lower end of this range, benefiting from investor confidence and lower risk premiums. However, the exact COF can vary based on deposit composition, market conditions, and competitive environment. The COF for an AA bank will generally track short-term rates with a lag of several months, and is usually about 0.5% to 1% lower than that of lower-rated peers due to their higher credit standing. Each notch downgrade from AAA typically increases funding costs by about 6 basis points (0.06%). For AA-rated banks, this means their funding cost is about 6 basis points higher than AAA, but still significantly below AA, A+, or lower-rated banks, where the interest penalty increases further with each lower rating notch. Over the last 100 days, the cost of funding and credit for AA-rated U.S. banks remain high, unrealized losses have increased with rate volatility, and tight spreads offer little cushion against risk due to persistent volatility + elevated credit risk, especially for lower-rated bonds. The outlook for the remaining 2025 is as follows: - Cost of Funding: Funding costs are expected to remain relatively high, as central banks are likely to keep interest rates “higher for longer” due to persistent inflation risks. There may be some volatility, but no significant decline in funding costs is anticipated in the near term. - Credit Risk and Default Risk: Credit fundamentals for investment-grade issuers remain stable, but there’s ongoing uncertainty in the macro environment. Default risks for high-yield bonds may rise slightly if economic growth slows, though strong corporate balance sheets are providing support for now. - Credit Spreads: Spreads are currently tight, reflecting strong demand and healthy issuer fundamentals. However, there is risk of spread widening if economic or policy shocks occur, which could lead to mark-to-market losses. Investors should be prepared for periods of volatility, especially given recent geopolitical and trade tensions. - Unrealized Losses/Mark-to-Market Risk: Interest rate volatility is expected to persist, impacting bond valuations. While yields remain attractive, price fluctuations could continue, especially if rate expectations shift or spreads widen. - Liquidity: Liquidity is expected to remain solid for investment-grade bonds due to ongoing strong demand, but could deteriorate quickly in risk-off episodes. - Operational and Regulatory Costs: These should remain stable, but ongoing uncertainty and volatility will require banks to maintain robust risk management and compliance efforts.

Bond market update outlining Economic growth and Banking liquidity outlook RBI has been proactively managing banking liquidity since January 2025 and has infused more than INR 6 trillion of liquidity into system through various tools. We expect core / durable liquidity to remain largely in surplus for Apr-Sept 2025 and expect additional 25-50 bps of rate cuts in next 6 months Market view We have remained positive on duration and long Government bonds throughout 2024 as demand supply dynamics for government bonds were favorable. The inclusion of government bonds in JP Morgan indices brought USD 20 billion of FPI flows into government bonds. Fiscal consolidation over the past two years has reduced the fiscal deficit from 5.4% to 4.4% of GDP. OMO purchases of over INR 2.5 trillion (Including secondary purchases) in Q1 CY 2025 by the RBI have addressed the deficit core liquidity problem In line with our macro view of shallow rate cut cycle and positive liquidity conditions we expect Short corporate bonds (3-5 year) to perform equal or better than long bonds in next 12-18 months. Rationale is as follows: • Banking liquidity to remain in surplus • Expected lower supply of corporate bonds/ CD due to slowdown and delay in implementation of LCR guidelines • Attractive spreads and valuations as highlighted in the note Incrementally Short bonds can outperform long bonds from risk reward perspective as: • The Rate cut cycle can be shallow due to recovery in Growth and external sector uncertainties like Tariffs, currency etc. • OMO purchases might be lower in H2, expect another INR 1-1.5 trillion of OMO purchases in next FY • As Govt has shifted from Fiscal deficit targets to Center's Debt to GDP targets incremental Fiscal consolidation from here on in future looks limited Complete detailed rationale is attached in note #liquidity #growth #rbi #monetarypolicy #fixedincome #mutualfunds #corporatebonds

Fixed Income Outlook 2025: What’s Next? The U.S. fixed income market is at a turning point. With 10-year Treasury yields at ~4.5%, three forces will shape the future: Inflation expectations GDP growth Term premiums Nomura’s scenario analysis highlights three possible paths: 1. Recession (10% probability) GDP shrinks (<0%). Inflation falls below 1%. Yields drop to 0-3%. Weak consumer spending and rising layoffs are key drivers. 2. Soft Landing (60% probability) Moderate growth (0-2%). Inflation stays controlled (≤3%). Yields stabilize at 3-4.5%. Resilient consumers and gradual Fed easing support this scenario. 3. Trump 2.0 Reflation (30% probability) GDP grows strongly (>2%). Inflation exceeds 3%. Yields rise to 4.5-6%. Fiscal spending, tariffs, and supply chain disruptions drive inflation higher. What’s Driving Rates? Short-term rates respond to policy actions. Long-term rates depend on growth, inflation, and term premiums. Higher fiscal deficits or geopolitical risks could push term premiums up. How Should Investors Respond? Stay short: Focus on shorter-duration Treasuries for better risk-reward. Be selective: Investment-grade credits are more resilient. Think tactically: Structured products offer yield enhancement and risk management. What’s the Big Picture? Trump 2.0 policies could reshape markets. Tariffs and fiscal expansion may fuel inflation. Portfolio flexibility will be critical in a year full of unknowns. 2025 offers both risks and opportunities. Will you be ready? #FixedIncome #EconomicTrends #InflationOutlook #InvestmentStrategy #TrumpPolicy #RatesForecast

📉 BofA's Revised 2025 Leveraged Finance Outlook: A Deep Dive into the Slowdown The leveraged finance market is facing stronger headwinds than anticipated, prompting Bank of America (BofA) to significantly downgrade its 2025 forecasts as per a recent PitchBook report. Here's what you need to know: Key Forecast Revisions 🔹 High-Yield Bonds: Projected to remain flat at $285Billion in 2025 (vs. $282B in 2024) 🔹 Leveraged Loans: Expected to decline 10% to $450Billion 2025 (from $502B in 2024) Underlying Causes of the Slowdown 1️⃣ M&A Activity Failing to Launch - Early 2025 optimism about Fed rate cuts and a pro-business Trump administration fueled expectations of an M&A boom - Reality check: Q1 2025 activity declined 22% YoY in high-yield bonds - Three major roadblocks: - Persistently high cost of capital (even with expected Fed cuts) - Rich valuation multiples making Leveraged Buyout (LBO) attractiveness challenging - U.S. trade tariff policy uncertainty creating hesitation among strategics and sponsors 2️⃣ Refinancing Dynamics Diverging - High-yield bonds: Active refinancing pipeline due to $150B+ maturities in 2025-26 - Leveraged loans: Fewer imminent maturities = lower refinancing urgency - Private credit competition: Increasingly taking refinancing share from syndicated loans 3️⃣ Structural Market Shifts - Sponsor activity muted: PE firms sitting on $1Trillion+ dry powder but constrained by: - High debt costs (avg. LBO debt multiples down to 4.5x from 5.5x peak) - Limited exit opportunities (IPO window remains shaky) H2 2025 could see improvement if: - Fed cuts materialize as expected (current forecast: 2-3 cuts in 2025) - Reduced policy uncertainty around global trade and tariffs - Valuation expectations reset between buyers/sellers Krishank Parekh | LinkedIn

The Fed’s decision to cut rates back to the 4.00%–4.25% range marks a turning point. For much of the past two years, policy was designed to lean hard against inflation. Now, the pivot signals the Fed believes it has regained enough traction to begin easing. But the bond market’s reaction tells a more complicated story.   Yields rising into cuts...   Normally, rate cuts ignite a rally in Treasuries, pushing yields lower. Instead, the 10-year yield has drifted higher. The reason is structural.   The market is adjusting not just to near-term Fed policy but also to a new neutral rate, which Federal Reserve Bank of Minneapolis President Neel Kashkari estimates to be around 3.1 percent. That’s well above the “old normal” of the pre-pandemic era, where neutral was closer to 2%.   Higher neutral means investors don’t expect rates to revisit the ultra-low environment of the 2010s. Even as the Fed trims the policy rate, equilibrium yields are repricing higher to reflect stronger trend growth, higher capital costs and heavier fiscal issuance.   A head and shoulders pattern in yields has broken above its neckline. In equity markets, that pattern would signal a bullish breakout. In bonds, it translates to a structural move to higher yields. A recognition that the cycle’s has shifted.   What’s driving this shift is a combination of resilient growth, global fragmentation, and fiscal reality. Investment in productivity, especially in AI and automation, has kept the economy from cracking under high rates. At the same time, tariffs and capital friction mean foreign demand for Treasuries is less elastic, which reduces the lid on yields. Add to this the scale of federal deficits, which necessitate sustained Treasury issuance, and the supply alone creates an upward bias.   The Fed may be easing, but this isn’t a return to the “lower for longer” playbook. Instead, the market is digesting a world where yields remain structurally higher, even through a cutting cycle. For investors, that means:   Income opportunities in fixed income are back in play, but entry points matter more than ever.   Risk assets will compete with a higher cost of capital, redefining valuations across real estate, equities and credit.   Peachtree Group Peachtree Group Credit Peachtree Group Hospitality Management Neel Kashkari Bloomberg #federalreserve #commercialrealestate #cre #hotels #multifamily https://lnkd.in/g-5Bjh3J

Bond Markets in Focus: Real-Time Perspectives for Buy-Side Investors - The fixed income landscape in 2025 offers both challenges and opportunities. With the U.S. 10-year Treasury yield trading around 4.28–4.34% and the 2-year near 3.75%, the yield curve shows a “U-shaped” structure, reflecting market uncertainty and a tug-of-war between growth, inflation, and policy expectations. - For buy-side portfolio managers, this environment highlights three core themes: -- Duration Management: Elevated long-end yields are reviving interest in long-duration strategies, while short-dated Treasuries remain attractive for capital preservation. -- Credit Selection: Investment-grade spreads remain resilient, but careful credit rotation between IG, HY, and EM is essential as default risks evolve with the credit cycle. -- Macro Positioning: Policy uncertainty remains high. The Federal Reserve faces pressure from both fiscal concerns and inflation dynamics, making September’s rate decision pivotal. -- Key takeaway: Bonds are once again central to asset allocation — not only as defensive anchors but also as active tools for generating alpha through curve positioning, spread trades, and tactical credit exposure. -- For context: - Reuters highlights the risk of “fiscal dominance” shaping Fed policy (Reuters, Aug 19, 2025). - Financial Content notes the unusual “U-shaped” Treasury curve as a signal of investor caution (Market Minute, Aug 19, 2025). - Kiplinger reports that September’s Fed decision on rate cuts remains uncertain (Kiplinger, Aug 2025). #FixedIncome #BondMarkets #InvestmentManagement #AssetAllocation #PortfolioStrategy #InterestRates #CreditMarkets #YieldCurve #BuySide #MacroStrategy

🗓️ The big macro story to start 2025 has been the continued, relentless rise in global bond yields …what does it mean for investors? 1️⃣ History tells us that it is unusual for bond yields to rise once the interest rate cutting cycle starts (see chart) Part of the story for higher bond yields has been a big revision in expectations for interest rate cuts in 2025. Today, investors assume 1-2 cuts from the US Fed and Bank of England this year. Back in September, analysts were pencilling in 5 cuts 2️⃣ Yield curves continue to steepen, but it’s not all about inflation Yield curves are “bear steepening”, as long term bond yields rise faster than short term rates. Normally, this pattern reflects reflation and rising inflation expectations. But this time around, long term inflation expectations have remained stable 3️⃣ Economists disagree why long term yields are going up Yield curve steepening is caused by a rising “term premium” – they say. This is a catch-all term that economists use for yield curve moves that they can’t explain. Rising global yields and steeper curves could be due to fiscal policy (what I have called “deficits forever”), expectations for more long term bond issuance, or even concerns of a policy mistake… 4️⃣ While rates rise, growth cools The big problem is that while interest rates are rising, growth momentum has disappeared. A broad measure of US economic activity published by the Chicago Fed shows subdued US growth since September. Economists expect global growth to cool in 2025. And Europe is in its own growth quagmire. This adverse shift in the rates-versus-growth arithmetic puts the whole macro system under pressure 5️⃣ Rising bond yields matter for all asset markets in 2025 The year 2024 was unusual because although short term interest rates markets were volatile, the credit and stock markets were calm. But the relentless rise in long bond yields – if not offset by better news on growth – is likely to matter for all asset classes in 2025. As macro and policy uncertainty rises, market volatility follows. The case for an active and opportunistic approach to investing in 2025 looks strong 🔔 Like and follow for more global macro and investment market updates #economy #investing #bonds Chart from HSBC AM Investment Weekly

Despite some short-term relief from month-end rebalancing, we believe that government bond yields face upward pressure over the medium term from a supply/demand perspective. There are two duration shifts that present a headwind for government bonds over the medium term. The first duration shift has been taking place in demand and has to do with the retail impulse into bonds. The YTD pace in bond funds is tracking pace of around $450bn-$500bn, a sharp decline from the $1.36tr seen in 2024. The picture looks even more problematic for bond demand if one takes into account the duration impulse. Not only have bond fund inflows slowed sharply this year relative to 2024 but these inflows have shifted away from longer duration government or corporate bond funds towards short duration funds. In other words, there has been an even bigger decline in bond fund demand in duration terms. The second duration shift has been taking place in supply. While the duration impulse of corporate bond issuance has been flattening out as corporates reduced sharply the maturity of their issuance, the duration impulse of government bond issuance continues to rise widening its gap with corporate bond issuance. This is shown in the chart below which depicts the notional amounts of USD corporate bonds in 10y-equivalent terms along with the equivalent metric for the Treasury excluding Fed holdings. In other words, much of the duration supply has been stemming from government bonds rather than corporate bonds.

🔴 The Bond Market was born to ensure safety. 200 years later, that safety net is crumbling. The Western bond market has just experienced its worst decade in 200 years of recorded history. The bloodbath unfolding in developed bond markets is due to 5 key reasons. [1] The first and most obvious reason is the Huge Debt Pile. The world has never before experienced such levels of sovereign debt. The developed markets are leading from the front in building this mountain of debt. In the year 2000, the total sovereign debt of the G7 nations was roughly 11 to 12 trillion dollars. By 2025, that figure has soared to over 62 to 63 trillion dollars. That’s a $50 trillion increase in just 25 years. Now creditors are beginning to worry: how will these countries repay such massive debt? That question is gaining traction among lenders. In response, lenders now demand higher interest rates to protect their capital, which means lower bond prices. When bond prices fall, existing investors face losses—and that’s exactly where we are now. [2] Fiscal Fallacy Despite already having massive debt, G7 nations paid little attention to fiscal discipline. Instead, they’ve continued deficit spending year after year. This deficit spending is piling onto the already growing debt burden. As the debt load gets heavier, the market is, for the first time, attaching real credit risk to sovereign debt. Because of this rising credit risk, bond investors now demand higher yields. Higher yield means lower bond prices—which again results in losses for existing investors. [3] Rise of Main Street Inflation For nearly 40 years, inflation wasn’t a major concern in the Western world. But after COVID, massive stimulus programs and direct cash handouts caused inflation to surge to double digits. That spooked bond investors. Now they’re deeply concerned about inflation making a comeback. Inflation erodes bond value the way fire consumes gasoline. Since 2020, investors have demanded higher returns to offset the impact of inflation. The only way to achieve higher returns in bonds is to buy them at a lower price. But lower prices mean existing investors suffer losses. That’s exactly what’s happening in the bond market today. [4] Low Productivity Debt needs to be repaid. But who can repay debt best? The answer is: the most productive. Productivity means producing more with greater efficiency. The harsh truth is that the West has lost its productivity growth. Its economy is now dominated by healthcare, finance, and consultancy—sectors that do not significantly improve real economic output or raise the standard of living. True productivity growth comes from industrialization and making complex, high-end products. It doesn’t mean garments, toys, or shoes—it means semiconductors, robotics, drones. But the West offshored its industrial base to feed the financial markets. In doing so, it lost the deep supply chains required for advanced manufacturing. 👇

As 2025 gets underway, I want to highlight four key themes that I believe will shape economic and financial market developments over the next 12 months and beyond. These themes in part reiterate points that I stressed over a year ago. The fact that they have played out as I expected over the past year bolsters my conviction that they will be even more relevant as we move forward into 2025. 1. Persistently loose fiscal policy will put increasing pressure on inflation and bond yields. 2. The US Federal Reserve’s easing cycle might already be over. I reiterate my long-held view that the neutral policy rate is probably around 4%, and I think 10 year UST yields will likely trade north of 5% by the end of the year. 3. Productivity growth might be shifting to a higher level, and help put the US economy on a stronger growth path. 4. I expect greater uncertainty and volatility in 2025: a new US administration will need to reconcile some of its election promises with its goals of stronger growth and lower prices. And the resurgence of protectionism is clashing against the costs of de-globalization, against the background of elevated geopolitical tensions #yearaheadoutlook #fixedincome #investmentstrategy #interestrates #fed #monetarypolicy #inflation #economy #fiscaldeficit #debt