A Trump presidency means many things. For bondholders, the key risk is the increased rates volatility through President Trump’s tariffs and policy announcements via social media platforms. Against this backdrop, Fidelity fixed income managers Kris Atkinson and Shamil Gohil highlight why they continue to find the best risk-adjusted opportunities in the front end of the Sterling credit curve and why they remain overweight this segment of the market in our all-maturity portfolios.
Maximum drawdown across different fixed income asset classes (duration in brackets)
‘Trump Tariffs’ and ‘Trump Tweets’ can increase rates volatility
It’s important to note that higher rates volatility was here irrespective of who won the US presidency because of the inflation backdrop and accompanying central bank response. However, as we have commented on in the past, the election of Trump as US President creates an additional element of uncertainty and rates volatility, making it harder to manage duration.
Firstly, Trump has spoken at length about tariffs which are likely to be inflationary but also growth negative. Fidelity’s Macro and Strategic Asset Allocation team estimate that the latest round of tariffs (At the time of writing, a 25% tariff on Mexico and Canada, and an additional 10% on China, on top of the 10% already implemented), if fully implemented, alongside what they’ve already applied, would be a +80bps impulse to headline PCE inflation. This clearly has an impact on rates volatility.
Tariffs also increase the likelihood of a growth slowdown or recession which should lead to steeper curves, thus an outperformance of short dated bonds versus their longer date counterparts, further making the case for front end bonds.
Furthermore, the communication technique via social media platforms adds another dimension to the volatility. During Trump’s first term, JP Morgan put together the ‘Volfefe Index’ to gauge the impact of the President’s tweets on US interest rates, they found that Trump’s tweets had a statistically significant impact on Treasury yields.
Higher rates volatility calls for lower duration risk
Amid elevated rates volatility, investors may be interested in lowering their sensitivity to interest rate risk and one way to do this is via short dated corporate bonds. As the rates driven sell-off in 2022 demonstrated, lower duration bonds like 1-5yr corporate bonds saw a significantly more muted drawdown compared to higher duration asset classes like all-maturity corporate bonds and gilts, and even saw a more modest drawdown compared to high yield bonds (which is a relatively low duration asset class).
Furthermore, 1-5yr corporate bonds recovered much more quickly relative to all-maturity corporate bonds and gilts. Figure 1 shows the maximum drawdown across a variety of fixed income asset classes from 2005 to 2025, and 2022 saw gilts, all-maturity corporate bonds and 1-5yr corporate bonds exhibit their largest drawdowns ever at -33%, -25% and -12% respectively. Note, we have included high yield corporate bonds which saw their largest ever drawdown at -28% during the Global Financial Crisis (which was more of a credit event than a rates event).
1-5yr corporate bonds have a duration of 2.5yrs which is around half that of all-maturity corporate bonds at 5.4yrs and close to a quarter of the duration of gilts at 9.0yrs. The lower duration profile of 1-5yr corporate bonds helped to limit the drawdown experienced during 2022 versus these higher duration asset classes.
Wipeout yields remain attractive in short dated corporate bonds
Another way to assess the attractiveness of 1-5yr corporate bonds is via the wipeout yield. Wipeout yields, also known as breakeven rates, are calculated as the yield-to-maturity divided by interest rate duration. They are expressed as the increase in yields required to “wipeout” one year of carry and so the larger they are, the greater the buffer against increased yield volatility or yield rises. Short dated credit tends to have a high wipeout yield due to its combination of attractive yield levels and low duration (high numerator, low denominator). As figure 2 shows, the wipeout yield on 1-5yr corporate bonds (1.9%) compares favourably to all-maturity corporate bonds (1.0%) and gilts (0.5%).
As expected, sterling high yield offers the highest wipeout yield (high yield and low duration), but this involves greater credit risk and a higher beta to negative risk events. To put these figures into context, during the worst risk off event in the last decade, the COVID sell-off in March 2020, short dated investment grade credit widened by 1.1x. During the same period, high yield credit widened by 5.5x, 5x the beta of investment grade. Given our current position in the economic cycle, where spreads are already very compressed and the double-B to triple-B spread is very low, we think that it makes sense to start switching from high yield into investment grade.
Wipeout yields across different fixed income asset classes
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Fidelity’s range of fixed income funds can use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. FIPM: 8876