Payden & Rygel: Opportunities and challenges facing an unconstrained bond strategy
Halfway through the 2025 “marathon”, investors face a tougher course than expected—policy headwinds from sweeping tariffs, tighter immigration, and the expansive One Big Beautiful Bill Act have added uphill miles for growth and inflation control.
The U.S. economy is slowing, yet equity and credit markets are still pacing for a soft landing despite stretched valuations. Our strategy keeps a steady stride: cautious on credit, overweight front-end interest rate exposure, favorable on emerging markets, and underweight the U.S. dollar—using elevated fixed-income yields as our “energy gel” to cushion the road ahead.
Overview
- The first half of 2025 proved more challenging than expected, with policy surprises outweighing macroeconomic trends.
- Clearer policy direction has emerged, but ripple effects remain uncertain.
Trump 2.0 Policy Mix
- Inflation and immigration were central to Trump’s re-election platform.
- Expected tax cuts and spending measures materialized but were collectively less fiscally disciplined than anticipated.
- April 2 (“Liberation Day”) tariffs: 10% baseline on nearly all imports, higher for large-deficit countries. Effective tariff rate rose to ~17% (from 2.5%), potentially cutting GDP by 1–1.5% over the next year and adding to inflation pressures.
- July’s One Big Beautiful Bill Act (OBBBA): Maintains budget deficit near 6.5% of GDP in coming years; fiscal outlook beyond 2026 uncertain.
- Department of Government Efficiency (DOGE) savings far smaller than official claims—independent estimates at ~$30B vs. $160–190B claimed.
- Immigration enforcement expected to cut 2025 GDP growth by ~0.4% and shrink labor force by 1–1.5%, potentially pushing wages up.
Treasury Supply & Interest Rates
- Anticipated shift to more long-term Treasury issuance under Secretary Scott Bessent did not occur; bill share remains ~22% of debt.
- Growth slowdown and falling short-term yields validated early-year strategy to favor front-end interest rate exposure over longer maturities.
Economic Conditions at Mid-Year
- Wage growth has cooled; inflation lower.
- Nominal GDP likely in 3–4% range—slowing spending, revenues, and profits unless productivity rises.
- Equity valuations stretched (S&P 500 forward P/E ~24x), high yield spreads near cycle tights, and markets priced for a “soft landing.”
- Risks remain as policy implications are still unclear and structural economic underpinnings weaken.
Investment Strategy Outlook (Second Half 2025)
- Credit: Modest underweight to credit risk; preference for emerging market debt and sectors tied to prime U.S. consumers (e.g., housing). Cautious on subprime consumer credit and cyclical sectors like energy.
- Rates: Overweight interest rate risk, favoring U.S. front end; adding exposure in select non-U.S. markets.
- Currency: Underweight U.S. dollar due to global overweight positioning and widening growth differentials.
- Elevated starting yields across fixed income should help cushion volatility.