From the Field: “Uneasy Equilibrium” Creates an Opportunity in Global Fixed Income

Kenneth A. Orchard Head of International Fixed Income 
Vincent Chung Portfolio Manager, Global Fixed Income

Key Insights

• The U.S. economy is presently in a state of “uneasy equilibrium,” but President Donald Trump’s policy agenda could stoke inflation and result in a higher rate environment.
• We believe a global fixed income approach would allow investors to take advantage of attractive opportunities arising from asynchronous economic and monetary policy cycles.
• A more global scope expands the rates universe, enabling investors to diversify away from overconcentrated U.S. duration exposure.

Since September 2024, the U.S. Federal Reserve (Fed) has lowered its benchmark interest rate by a full percentage point. However, the market’s reaction to the start of the Fed’s long‑anticipated easing cycle has been perplexing for many investors as yields on 10‑year U.S. Treasuries rose sharply over the period.  
 

Slower easing ahead

(Fig. 1) Inflation risks and strong labor halting Fed cuts

Image

December 31, 2021, to December 31, 2024. 
PCE = personal consumption expenditures. Actual outcomes may differ materially from forward estimates. 
1 Federal Open Market Committee participants’ assessments of uncertainty and risks, risks to core PCE inflation, weighted to upside, estimate. 
Sources: Bloomberg Finance L.P., Macrobond/Federal Reserve. 
 

An uneasy equilibrium

Recent U.S. economic data offer a hint about the underlying factors behind the atypical bond market movements. Although job growth unexpectedly surged in December, the inflation print for that month was largely benign, as it showed core consumer prices moderating slightly. Hence, T. Rowe Price’s Chief U.S. Economist Blerina Uruçi suggested that the U.S. economy is presently in an “uneasy equilibrium” where tight labor markets and resilient activity are not significantly pushing up inflation—for now.

This fragile balance could be easily upended, however, particularly given heightened policy uncertainty following Donald Trump’s return to the White House. While President Trump’s policy agenda is well telegraphed, many questions persist on how and when his plans will be implemented, along with their potentially divergent impacts on the economy and inflation. For example, a fiscal package to extend the 2017 tax cuts may lift growth at the margin this year but also contribute to an unwelcome tightening in the labor market. The specter of higher import tariffs and aggressive immigration reform are also likely to bring upside risks to inflation.

Beyond this, concern is growing about the sustainability of sovereign debt levels across the developed world, which have ballooned as countries sought to support their economies in response to the coronavirus pandemic. Consequently, global rates markets, led by the U.S., have become highly sensitive to headlines that might disrupt prevailing narratives.

All of the above point to further uncertainty over the path for U.S. interest rates. Already, the Fed has pivoted to a more hawkish tone, with policymakers signaling concerns about potential inflationary risks associated with the new administration’s policies. Interestingly, some investors had begun to completely price out any rate cuts in 2025. We still believe, however, that the Fed will reduce borrowing costs twice, albeit toward the back half of the year. Nonetheless, that would still leave the “terminal rate,” or the interest rate level required for a balanced economy, in a 3.75% to 4% range, well above an estimated pre‑pandemic neutral rate of 2.5%. From this perspective, it’s clear that expectations of an environment of generally higher rates, not just higher for longer, have gathered momentum recently.

Outside the U.S., the global economy is also arguably in a state of uneasy equilibrium, with global growth just strong enough to avoid recession. The story starts with China, which has turned to excess industrial production to maintain its growth pace while grappling with a seismic residential property overhang that has paralyzed consumption. As a result, China has been an exporter of deflation, leading to stiff headwinds for manufacturing and commodity‑based economies in Europe and Latin America. 
 

Divergent monetary policy is today’s fixed income reality

(Fig. 2) Illustrative interest rate cycles for developed and emerging economies

Image

As of December 31, 2024. 
For illustrative purposes only.  
These represent estimates of where the stated countries are in their monetary policy cycle. Actual future outcomes may differ materially. 
Sources: IMF, CB Rates, with T. Rowe Price analysis. 
 

A good moment for global fixed income

With high‑duration U.S. assets potentially struggling amid continuing U.S. economic exceptionalism, we believe it is a good “moment” for global fixed income. This is because today’s world is less globalized than before, with different countries and regions at varying stages of their economic and monetary policy cycles.

In our view, this asynchronous profile opens up various appealing diversification and total return opportunities for bond investors in 2025. Consider, for example:

• The European Central Bank is likely to continue aggressively easing its policy stance in the first half of 2025 amid continued soft activity levels;
• Canadian monetary policy, historically closely correlated with the U.S., has meaningfully diverged;
• Dynamic and independent monetary policy can be seen from emerging market central banks, exemplified by recent monetary policy trends in Latin American countries, such as Brazil and Chile; and
• Although China has begun to resemble Japan’s deflationary experience from the 1980s from a rates perspective, signals that Beijing could ramp up stimulus with a focus on boosting consumption could easily change the narrative.

Prospects for some other markets appear positive too. Amid rising trade tensions between China and the U.S., Southeast Asian countries, such as Malaysia, the Philippines, and Vietnam, along with India and Japan, may be economic beneficiaries. 

A more global fixed income approach in 2025 would enable investors to gain exposure to some of the compelling opportunities mentioned above. Notably, taking advantage of the full global bond opportunity set allows for the identification of more promising and better‑valued investment options across a wider array of markets. More importantly, this would help to diversify sources of returns and risks, which can provide a buffer in times of higher market volatility. 
 

U.S., UK, and China bond yields

(Fig. 3) A major divergence occurred in 2024

Image

As of January 26, 2025. 
Past performance is no guarantee or a reliable indicator of future results. 
Source: Bloomberg Finance L.P. 
 

The case for an active, diversified approach in 2025

In a landscape laced with uncertainty, investors continue to seek solutions that can deliver consistent income while remaining resilient against ongoing macro and political crosscurrents. In our view, this reinforces the case for considering an allocation to global fixed income, which could allow investors to lock in attractive income streams by taking advantage of still‑elevated yields, while offering the potential for steadier returns by harnessing the benefits of diversification. A more global scope also expands the rates universe, enabling investors to express directional and relative value views on rates worldwide and diversify away from overconcentrated U.S. duration exposure. In addition, it opens up access to a wider range of fixed income sectors beyond rates, including credit sectors, securitized assets, and emerging market bonds, some of which may offer even better carry and income potential. 

However, with volatility expected to persist, being disciplined and selective also becomes increasingly important. Hence, we believe that an active and flexible investment approach that is able to tactically adjust exposures as market conditions evolve, coupled with maintaining effective diversification, is especially suited to today’s uncertain environment.

Diversification cannot assure a profit or protect against loss in a declining market. 

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