The traditional world order – in which economics shaped politics – has been turned on its head, with politics now driving economics. Sharp policy shifts are transforming long-standing trade, security, and economic alliances, with the effects set to reverberate for years. This fragmentation will likely become an independent driver of winners and losers, business cycles, and market volatility. Moreover, industries favoured by national policies are now in play based on changing administrations and regional priorities – evident in the U.S. pivot toward legacy fossil fuels and autos and Europe's renewed focus on defence.
Uncertainty about the endgame for trade policy and global security alliances has increased downside risks to global growth. Without sustained retaliation against the U.S., the trade war mostly lowers export demand – a disinflationary impact – for much of the world. The reallocation of China's trade surplus to the rest of the world is a clear source of disinflationary risk. In contrast, U.S. inflation risks have risen, at least in the short term, as has the likelihood of monetary policy divergence between the U.S. and other countries.
We believe it would be almost impossible for the dollar to lose its dominant global reserve currency status over our secular horizon, in part due to the lack of viable challengers in markets for foreign exchange, foreign currency debt, and bank lending. But dollar bear markets are possible, over both the short and long term, reflecting historical multiyear dollar cycles. Changing policy and security priorities may alter relative global demand for U.S. and other assets – especially as overseas investors reassess their tolerance for unhedged dollar exposure.
Although it is near record highs, debt remains sustainable in most developed countries. Notable exceptions include Japan, the U.S., and France, where debt is on an unsustainable long-term trajectory, even more so than last year. However, these issues appear chronic rather than acute and we do not foresee a sudden fiscal crisis but instead expect episodic market volatility. Overall fiscal space remains constrained, limiting room to respond to future downturns, although central banks have much more space to cut rates than in the decade before the pandemic.
Outside of the U.S., major developed market (DM) economies face distinct growth challenges, while emerging market countries are bolstered by prudent debt management but also influenced by global trade shifts and DM policies.
Investment implications
In fixed income, investors are paid to build resilient portfolios. We continue to advocate seizing the yield advantage in high quality bonds rather than chasing equities at elevated valuations.
Valuations point to a lower probability of equity outperformance over fixed income in part because the outlook for high quality fixed income is as good as it has been in a long time. After steep post-pandemic rate hikes, bond markets have made it to the other side: Investors can now benefit from higher yields plus potential price appreciation given central banks have ample room to cut rates. By contrast, equity valuations remain stretched, with similar levels having preceded major corrections.
Over a secular horizon, the starting yield on a bond portfolio can be a good guide to expected returns (Figure 1). From this point, active managers can seek to construct fixed income portfolios yielding about 5%–7% by capitalizing on attractive yields available in high grade investments. We anticipate maintaining an up-in-quality bias.
Figure 1: Strong link between starting bond yields and five-year forward returns
Source: Bloomberg and PIMCO as of 30 May 2025. Past performance is not a guarantee or a reliable indicator of future performance. Chart is provided for illustrative purposes only and is not indicative of the past or future performance of any PIMCO product. Yield and return are for the Bloomberg U.S. Aggregate Bond Index. It is not possible to invest directly in an unmanaged index.
Harnessing global opportunities through active strategies
Active management, with the agility to exploit country-specific nuances and relative value differences, is crucial to navigating inevitable volatility from powerful secular forces. The opportunity to generate alpha – returns exceeding market benchmarks – is as rich as it has ever been across global markets.
Many DM economies offer a combination of attractive bond yields and a challenged economic outlook, which can benefit bond investors. In addition, we see EM countries building upon their demonstrated resilience. Historically, global diversification has offered superior volatility-adjusted returns to single country portfolios. We believe that diversification is the one free lunch available to asset allocators.
The importance of duration and curve positioning
Given attractive starting valuations in fixed income, along with expected weaker growth and stabilizing inflation, we anticipate being biased to run more overweight duration positions in our portfolios than has been typical in recent years. A core PIMCO thesis remains that yield curves will re-steepen over our secular horizon, as investors continue to demand more compensation to hold longer-term bonds relative to cash and short-term bills. Estimates of the Treasury term premium are positive and up substantially since the decade before the pandemic. There is potential for further steepening given the budget debate in the U.S.
Active management can enhance bonds' role as a hedge through yield curve positioning. We anticipate maintaining a bias to be overweight in the 5- to 10-year part of global yield curves and to be underweight in the long end over time.
Resilient opportunities beyond corporate credit
Credit spreads remain tight relative to historic averages, despite elevated secular recession potential, highlighting areas of complacency across public and private corporate credit markets. Amid limited fiscal space, a genuine credit default cycle – unlike the recent "buy the dip" era – may unfold for the first time in years, catching many investors unprepared.
In a weaker growth environment, lower-quality, economically sensitive companies face risks. Elevated short-term interest rates could increasingly challenge midsize companies that borrow in floating-rate debt markets. We express caution in areas of corporate private credit where capital formation has outpaced investable opportunities, leading to potential disappointment. Stresses are becoming evident in private equity and private credit and could worsen sharply in a recession.
Stricter bank capital and liquidity rules will likely continue to push many lending activities in the U.S. to the private credit market, especially asset-based finance. This opens opportunities for investors to act as senior lenders in areas once dominated by regional banks. We continue to see attractive opportunities in high quality areas including consumer, residential mortgage, real estate, and hard assets.
Past performance is not a guarantee or a reliable indicator of future results.
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Private credit involves an investment in non-publically traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Management risk is the risk that the investment techniques and risk analyses applied by an investment manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to the manager in connection with managing the strategy. The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. Diversification does not ensure against loss.
Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
The terms "cheap" and "rich" as used herein generally refer to a security or asset class that is deemed to be substantially under- or overpriced compared to both its historical average as well as to the investment manager's future expectations. There is no guarantee of future results or that a security's valuation will ensure a profit or protect against a loss.
Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.
Correlation is a statistical measure of how two securities move in relation to each other. Duration is the measure of a bond's price sensitivity to interest rates and is expressed in years.
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