Position for lower rates
Falling rates in 2025 will jeopardize cash returns, so diversify into bonds and equity income strategies for income.
We expect central banks to cut interest rates further in the year ahead, reducing cash returns. We believe investment grade bonds offer attractive yields and expect mid-single-digit returns in US dollar terms. Diversified fixed income strategies and equity income strategies can also help investors sustain portfolio income.
High grade and investment grade bonds
High grade and investment grade bonds
We have a positive outlook for both high grade (government) and investment grade (IG) bonds.
After the recent increase, yields on quality bonds are once again attractive, in our view.
USD IG and EUR IG yield 5.3% and 3.2% at the time of writing. Corporate fundamentals are robust, in our view, with limited expected deterioration in credit quality. And we anticipate the global rate-cutting cycle to contribute to supportive technicals and investor inflows, helping credit spreads stay tight.
In our base case, we expect IG to deliver mid-single-digit total returns in USD, EUR, and GBP. These returns come from both yield (accounting for around two-thirds of returns) and capital appreciation (around one-third), as steepening yield curves mean investors benefit from “roll down” as bonds approach maturity.
Investment grade bonds are also appealing from a risk management perspective. While a tariff shock is a potential risk, IG bonds should perform strongly in a hard landing scenario. In such a scenario, we would expect falls in government bond yields to more than offset higher credit spreads.
Diversified fixed income strategies
Diversified fixed income strategies
Although spreads for lower-quality credit are tight by historical standards, and we believe the risk-reward profile of investment grade bonds is more favorable, we also expect respectable absolute returns for riskier credits in the year ahead. Solid economic and corporate fundamentals should keep default rates low, and investor inflows should keep spreads tight.
As such, in a portfolio context, we think that complementing IG bonds with riskier credit (like US, EUR, and Asia high yield, emerging market bonds, or senior loans) can improve diversification and increase returns.
For investors managing single bond portfolios, we recommend a focus primarily on quality bonds but augmenting those with select investments in short- and medium-duration riskier credits. We advocate staying in liquid parts of the bond market to maintain flexibility to take advantage of new opportunities.
Target portfolio composition depends heavily on individual risk appetite, but for an investor with a moderate risk tolerance, we would typically recommend allocating 20-40% of a fixed income portfolio to sub-investment grade and emerging market credit.
Equity income strategies
Equity income strategies
Investors seeking income can also consider equity income strategies, including high dividend, dividend growth, or option premia strategies.
The MSCI AC World High Dividend Yield Index is forecast to yield 3.5-4.0% in 2025, according to Bloomberg consensus estimates, a level likely to surpass cash yields by the end of the year. Considering high-dividend yielders that have a track record of consistently growing dividends can improve income sustainability.
Options strategies, including put writing and covered-call writing, can further enhance income potential. By harvesting volatility premia, such strategies can further diversify sources of portfolio income and may be treated as capital gains (rather than income) in some jurisdictions.
We estimate mixing high dividend, dividend growth, and option strategies could deliver a total yield of around 5-7% per year.
How far will central banks cut rates?
How far will central banks cut rates?
At the time of writing, rates are 50-75bps below their recent peaks in most major economies.
But even after recent cuts, rates remain restrictive, in our view.
We think that as 2025 advances, most major central banks will want to bring interest rates back to a level that is neither stimulative nor restrictive for the economy. From current levels, we expect a further 125bps of cuts from the Fed, 50bps from the Swiss National Bank, 125bps from the European Central Bank, and 100bps from the Bank of England.
The Fed has stated that it will be monitoring the net inflationary effect of new US policies as they are introduced, and we think it could cut rates more slowly if inflationary risks rise. But in our base case, we do not expect new US policies to have a significant upward impact on inflation and believe the Fed would likely look past one-off price rises related to tariffs. It is also important to remember that rates could fall faster than in our base case in the event of a consumer-led slowdown in economic activity.
We recommend limiting cash and money market holdings to the amount needed to cover one year of spending needs. For funds needed to cover the next three to five years of spending needs, high-quality bonds and bond ladders can help to minimize reinvestment and market timing risks. For funds not needed in the next three to five years, we recommend investing into a core long-term multi-asset portfolio.
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Disclaimers
Disclaimers
Year Ahead 2025 – UBS House View
Chief Investment Office GWM | Investment Research
This report has been prepared by UBS AG, UBS AG London Branch, UBS Switzerland AG, UBS Financial Services Inc. (UBS FS), UBS AG Singapore Branch, UBS AG Hong Kong Branch, and UBS SuMi TRUST Wealth Management Co., Ltd.