Positioning your portfolio in a complex environment
For investors, the goal is to build in carry, protect capital, and stay tactical through volatility
MARKETS entered the second quarter of 2025 on edge. Fresh tariffs sparked sharp market reactions, adding to an already complex investing backdrop and clouding visibility regarding inflation, growth and rates.
Fixed income is in investors’ focus, as carry, income and diversification are more critical than ever. With spreads still tight, this is not a blanket buy-the-dip environment. Multiple dislocations and selective opportunities will reward active positioning.
In the meantime, the US consumer is in good shape and may provide some ballast to the current disruption. Consumer strength continues to anchor growth, though net-worth trends differ across the income spectrum. Under the surface, labour market fragilities are emerging, with wage inflation easing and the quit rate continuing to fall. That may help ease inflationary pressure, but it could also signal reduced momentum ahead.
After a decade of ultra-low rates, the current confluence of short- and long-term forces muddy the picture. The mix of policy shifts, fiscal activism, deglobalisation, and energy transition is creating both short- and long-term crosswinds.
Tariffs have reintroduced uncertainty around business and consumer sentiment, and it’s unclear whether some of the related damage could be permanent. While tax reform and deregulation remain potential tailwinds, these will take time to materialise.
Thicker tail risks amid uncertainty
The US Federal Reserve and European Central Bank may be caught between cyclical headwinds and structural forces from post-pandemic adjustments, fiscal activism, deglobalisation, and the energy transition. The inflation path has improved; but with inflation and growth concerns rising, market focus is shifting. The Fed’s decision to slow quantitative tightening will have a marginal impact, potentially supporting Treasury demand.
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Our base case remains a moderation scenario, but we’ve raised our recession probability from 15 to 20 per cent. It’s not so much a call on imminent contraction as it is a recognition of thicker tails. Markets are increasingly pricing in uncertainty rather than calling an outright recession. Investors now demand higher compensation to stay invested.
We remain constructive on fixed income in absolute terms from current yield levels, and in relative terms versus cash and equities, given the looming downside risks.
Meanwhile, the US dollar is now at the intersection of currents. After coming under pressure in Q1 and posting one of its largest quarterly drops in recent history, tariffs have added a drag on the US dollar, without a clear growth or rate advantage. While US exceptionalism once supported the dollar, it is now caught among competing forces at the intersection of growth, trade, and policy risks.
Selective exposure is key
Credit spreads have remained snug by historical standards even after some recent widening. Valuations are rich, reinforcing the need for selective exposure. We lean slightly towards Europe over US corporate debt given better relative value and macro dynamics, but we will monitor this closely. Overall, credit remains a carry game. We like the protective qualities of owning fixed income.
High yield has continued to show wide dispersion, fostering opportunities but also serving as a warning. Credit selection is pivotal in a market where stronger issuers are diverging from weaker names.
We are constructive on short-duration high yield within the broader leveraged finance landscape, with a net supply deficit, attractive absolute yields, and an overall supportive credit environment.
But the impact of higher rates on operating leverage will take time to show up, so caution is warranted. We are underweight in cyclicals and potential tariff-impacted names in Europe.
High-quality securitised credit continues to offer attractive risk-return profiles. Short-dated investment grade and BB/B-rated high yield also screen well. Beyond that, the risk-return profile drops off fast.
Lower-rated credit exhibits equity-like volatility with little excess return potential to show for it. We’re defensive overall and look for quality or short carry to balance risk and return effectively.
Staying tactical through volatility
From a sector perspective, the key is to remain selective and tactical. On the investment-grade side, we continue to like large money centre banks and utilities with stable fundamentals and predictable cash flows. We avoid retail, where shifting AI and consumption trends pressure margins and capex.
Loans have performed better than expected and offer idiosyncratic upside in select names. Modest exposure to 10-year Treasuries may also provide balance in the belly of the curve.
Tight spreads, geopolitical crosscurrents, and policy uncertainty demand a hands-on approach. We continue to emphasise relative value opportunities. A barbell strategy combining high-quality carry with opportunistic risk remains our preferred stance. Structured credit and shorter-duration high yield are core commitments, while we remain underweight on long-duration investment grade, where risk-reward looks weakest.
Fixed income still holds advantages over cash and equities, especially if rates decline from serious market downdrafts. In a market defined by policy confusion and turbulence, bond exposure can deliver income stability and downside protection.
The lesson for investors is clear: Don’t confuse extreme market moves with changes to fundamental value. The goal is to build in carry, protect capital, and stay tactical through volatility.
The writer is managing director and co-chief investment officer, PGIM Fixed Income
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