Why prospects for fixed income have improved

Higher interest rates and an uncertain market environment could provide a tailwind for fixed-income markets, says Fidelity's Michael Plage.

• The combination of high starting interest rates, demographics, and the uncertain longer-term impact of policy changes could continue to be a supportive backdrop for fixed-income investments, according to Fidelity Portfolio Manager Michael Plage.
• "The Federal Reserve cut rates in September, November and December, with the potential for more reductions in 2025, mitigating the risk that the central bank reverses course and raises rates in the near term — and potentially presaging a modest tailwind for bonds," says Plage, who co-manages Fidelity Advisor^® Investment Grade Bond Fund.
• The fund's managers maintain significant flexibility to shift the portfolio to take advantage of wherever they see opportunity in the fixed-income marketplace, focusing on providing a high yield while closely managing volatility.
• "Markets have grown concerned that the new U.S. presidential administration will not reduce deficit spending and that debt as a percentage of GDP will continue to grow," says Plage. "In addition, bonds are pricing in the expectation that funding this spending will consist of a higher proportion of notes and less T-bill issuance, steepening the yield curve and putting upward pressure on longer-term yields."
• Plage believes this situation should provide the Fed with added flexibility to pursue its desired policies and potentially keep cutting rates. In the near term, he says this will help the Fed continue to normalize interest-rate policy and, in the long term, aid in stimulating the economy if growth slows.
• "Because we see a broadly favorable environment for fixed income, we've been keeping the portfolio sufficiently diversified to compound the relatively high yields available in the marketplace, while being ready to take advantage of dislocations as they occur," he explains.
• Across the bond market, Plage sees yields as especially compelling, while credit spreads offer very little additional compensation. Accordingly, the co-managers have been careful not to over- or underemphasize any individual category in the portfolio since they see opportunity across the fixed-income market.
• Instead, Plage and his co-managers have sought to improve the fund's diversification by limiting its segment over- and underweights — a stance they see as prudent to manage risk while continuing to provide the fund with attractive income.
• "When uncertainty is high, it makes sense to reduce risk in the portfolio, shorten the investment horizon and wait to see what opportunities present themselves down the road," Plage says.
• He stresses that they'll be monitoring market conditions as they evolve, and they won't hesitate to shift the portfolio when particularly compelling opportunities arise.
• "With relatively high exposure to U.S. Treasurys, we're currently providing the fund with sufficient liquidity and flexibility to take advantage of those opportunities when they emerge," Plage concludes.