AXA IM: Bonds are once again a stable and profitable portfolio building block

December 3, 2025

_{This interview was originally written in Dutch. This is an English translation.}

Bonds are well on their way to regaining their firm place in investment portfolios after the interest rate shock of 2022. Chris Iggo, Chief Investment Officer Core Investments at AXA Investment Managers (part of BNP Paribas), explains where the opportunities lie and which factors could accelerate the rise of bonds.

By Michiel Pekelharing

Following the sharp rise in interest rates three years ago, many investors are still reluctant to fully commit to fixed-income securities. To what extent do investors have a realistic view of the role that bonds can play in their portfolios?

'I think we are slowly returning to a normal bond climate. The rate reset three years ago was dramatic. Many bonds with longer maturities have not yet fully recovered their losses. As a result, there is still a kind of negative memory, as if bonds are inherently risky. But that image is no longer accurate. Bond yields are now at a level we haven't seen in more than ten years, while the chance of another interest rate shock is small. In Europe, the ECB has already cut interest rates several times and the market expects the policy rate in the United States to fall further this year. Even in the United Kingdom, the Bank of England may see room for easing within six months. All of this makes the yield curves steeper and real yields more attractive. We are now seeing a phase in which investors are once again realising that bonds are a stable, income-generating building block in the portfolio.'

So bonds are regaining their status as a safe haven?

'That recovery is clearly visible. We are seeing strong inflows into our bond funds, especially in short-term strategies. Investors want returns, but without the interest rate risk of longer-term bonds. Products with an average maturity of two to three years are hugely popular. They offer attractive carry and, on top of that, a little capital gain, as central banks are cutting interest rates. Across the board, the bond market is once again performing in line with historical averages. What is still missing is the ultimate test of a significant equity correction. Until that happens, we will not know whether bonds are once again the powerful diversification tool they once were. But I expect that the next equity sell-off will see a huge capital flow into bonds.'

The combination of attractive carry and limited duration risks currently makes short-term bonds the sweet spot.

The 60/40 portfolio model, which for years was considered the gold standard in the investment world, was declared dead by various strategists after the interest rate reversal. Was that perhaps premature?

'Definitely. The 60/40 model is back. We have carried out simulations of what a diversified portfolio would yield over twenty to thirty years if you rebalance periodically. That still amounts to around 10% per year. The rate reset temporarily disrupted this picture. Interest rates are now back at a healthier level, restoring the balance between risk and return. Bonds are once again making a structural contribution to total return and risk diversification.

To be honest, I am now more concerned about the 60% that investors hold in equities. This is particularly true for equities in the United States, where valuations are high and the market is extremely dependent on a handful of technology stocks. Ironically, a stock market correction would be good news for bond investors, as it would further increase the attractiveness of fixed income.'

Where exactly does the current bond yield come from? And which segments stand out?

'The majority of the total return comes from coupon income rather than price increases. That is exactly how bonds are supposed to work. The best performance was seen in high-yield loans and emerging market debt, simply because the initial yield was high. But short-term investment-grade bonds and inflation-linked bonds also performed well. The short end of the yield curve clearly outperformed the long end, partly because investors are sceptical about the sustainability of public finances in the longer term.

The combination of attractive carry and limited duration risks currently makes short maturities the sweet spot. At the same time, credit spreads have become very narrow. Investors receive little extra compensation for the risk they run with corporate bonds, while the total debt burden of companies is increasing. That makes me a little more cautious. There is a point at which credit and equities become too expensive in relation to their risk. We therefore focus on quality. These are investment grade bonds from companies with robust balance sheets and predictable cash flows.'

The big risk is that the Federal Reserve will lower interest rates too quickly under political pressure, especially if Donald Trump regains influence over policy.

Politics seems to be playing an increasingly important role in the bond market. How concerned should we be about fiscal policy and rising debt levels?

'Very concerned. The duration premium in government bonds is now determined more by politics than by inflation expectations. In France, for example, the government is struggling to form coalitions to approve a budget, which is leading to higher spreads. In the UK, a new budget is expected in November. There is a good chance that taxes will have to be raised after all, despite earlier promises. And in the US, fiscal policy has gone completely haywire. Investors see this and are demanding higher interest rates as compensation. This explains why spreads between countries are widening. We will see more “mini-Truss moments”, in which markets suddenly lose confidence, as happened three years ago in the UK when Prime Minister Liz Truss presented a very shaky budget. In fact, this is already happening to some extent in France. Interest rates there are higher than in Italy or Spain. Five years ago, that would have been unthinkable. Politicians now know that the bond market cannot be ignored. Japan's new prime minister even said explicitly: “I am not Liz Truss”. That says everything about how sensitive governments have become to investor reaction.'

Are government bonds still attractive? Or should investors seek refuge in corporate bonds?

'Actually, both, but I have to nuance that answer a bit. Companies with high credit ratings are often in a better financial position than governments. A spread of 100 basis points above government bonds is still attractive, especially if you can reinvest that return over several years. But for high-yield or highly leveraged bonds, it's a different story. There, the compensation for the risk is limited. Look at the recent problems in the leveraged loan market. The complex, opaque structures there remind me of the period before the financial crisis. That corner of the market could still cause turmoil. We therefore prefer short-term, well-structured corporate bonds. On the government side, we see particular value in the United States and the United Kingdom, where 10-year yields are around their fair value of around 4% to 5%. This is in line with nominal GDP growth. German Bunds are still somewhat expensive due to their safe-haven status. France and the UK, on the other hand, have slightly higher interest rates than justified, due to negative sentiment surrounding their budgets. In our portfolios, we remain positioned slightly shorter in duration to limit the risk of further interest rate rises.'

Negative interest rates? They won't be coming back. That policy has eroded confidence in savings and price mechanisms. No one will make that mistake again.

Meanwhile, the Bank of Japan has started to raise interest rates. Is a change in the carry trade something that bond investors and other investors should be concerned about?

'Japan is a special case. The country has been able to carry a high level of public debt for decades because it has a huge domestic savings base. Pension funds and insurers buy most of the government bonds themselves. However, this is changing as ageing reduces demand for long-term bonds. But that change is happening very slowly. The Bank of Japan is trying to normalise cautiously, but runs the risk of overreacting to a temporary spike in inflation. If Japanese interest rates rise structurally, this could affect foreign markets. In that scenario, Japanese investors would invest less in US or European government bonds, leading to higher interest rates there. The yen would also appreciate. This is not yet the case, but it is an important point to consider for 2026. The role of private Japanese investors in global capital flows is often overestimated. Their foreign bond purchases mainly follow the activities of Japanese insurers in those countries, not speculative money flows. So yes, Japan is relevant, but it does not pose a direct threat.'

Looking ahead to 2026, where are the biggest opportunities and risks for bond investors?

'In the short term, it's all about carry, or income from bonds. This remains attractive in short-term high-yield and investment-grade bonds. As US interest rate cuts draw nearer, there will also come a time when longer maturities become interesting. For the time being, a US 10-year Treasury with a 4.2% interest rate is not exciting enough, but that will change as it approaches 5%. The big risk is that the Federal Reserve will lower interest rates too quickly under political pressure, especially if Donald Trump regains influence over policy. Interest rates that are too low could reignite inflation. And then the next cycle of tightening would quickly become a reality. That is why we are enthusiastic about inflation-linked bonds as protection. In Europe, China is also exporting deflation through lower export prices. This is putting pressure on European inflation and may force the ECB to ease further, perhaps to a deposit rate of 1%. But negative interest rates? They will not return. That policy has eroded confidence in savings and price mechanisms. No one will make that mistake again.'