Outlook

Fixed income 2025 outlook

Rate divergence, trade policy volatility are themes to watch

January 13, 2025

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Fixed Income for the year ahead

Through 2024, the BMO Core Plus Bond Fund strategy quietly outperformed guaranteed investment certificates (GICs).1 We expect to see continued outperformance for 2025 given the aggressive easing policy that the Bank of Canada (BoC) has embarked upon combined with the attractive all-in yield of corporate bonds.

We believe that the economic backdrop for 2025 is conducive for increasing exposure to corporate credit assets, including Investment Grade and selective High Yield names. This view is anchored by the pro-growth policies of a Trump presidency in the United States. Although the risk of tariffs is non-negligible, we believe that the details and implementation will not be realized until the latter half of the year, thereby allowing the economic expansionary impulse to outweigh the possible inflationary impacts of tariffs.

Additionally, we will look for opportunities to extend Duration2 in Canada as we believe that the Canadian yield curve3 will be relatively contained due to the weaker domestic economic backdrop and the market’s anticipation of further easing of monetary policy by the BoC as compared to the Federal Open Market Committee in the United States. Going forward we expect the BMO Core Plus Bond Fund to outperform.

Positioning & allocations

Our highest conviction view for 2025 is persistent volatility.4 The main driver of volatility will be the rolling threats stemming from the Trump trade policy agenda that will continue to put pressure on the tight valuations for corporate credit. Volatility is conducive to active management as it allows us to be both nimble and patient in pursuit of higher returns. Throughout the year, we will approach risk-off periods as an opportunity to add to High Yield credit5 (given the very tight valuations entering 2025) and any move towards higher yields as an opportunity to extend Duration given the yields we are seeing above inflation.

Long real rates (U.S. Treasury Inflation Protected Securities, or TIPS) should remain attractive. U.S. 10-year real rates at 2% offers a compelling real return over inflation, especially given the uncertainty around the details of Trump tariff policies which may risk re-igniting an inflationary environment.

In addition, we anticipate yield curve steepening in both Canada and the U.S. but have a higher preference for a Canadian curve steepening.6

Why? We anticipate more relative monetary policy easing by the BoC compared to the Federal Reserve. The upcoming Canadian election may also lead to an increase in the fiscal deficit due to increased spending, which will add to the supply of longer dated bonds.

BMO GAM Multi-Asset Solutions Team (MAST) 2025 Fixed Income scorecard

Duration: +1 (Slightly bullish); 10-Year Canadian – 0 (Neutral) Yield curve: +1 (Slightly bullish); 2-Year/10-Year Canadian - +2 (Bullish)
Duration: +1 (Slightly bullish); 10-Year Canadian – 0 (Neutral) Yield curve: +1 (Slightly bullish); 2-Year/10-Year Canadian - +2 (Bullish)

Outlook summary

We prefer to start the year positioned long on the shorter end (the 2-year sector of the curve) given a combination of the recent sell-off in the short end and our anticipation of further easing in both Canada and the U.S.

We expect the terminal rate to be 2.75% in Canada and 4.00% in the U.S. with a risk of rates going lower.7 Again, we will use any sell-off as an opportunity to extend Duration. Our target buying zone for 10-year U.S. Treasuries is 4.50%-5.00%.We see the potential for a yield curve steepener, driven by a rally in the 2-year sector.

We also maintain a small preference for Canadian Investment Grade (IG) as we enter the year, given better valuations than U.S. IG. We will, however, be looking for opportunities to buy High Yield on any risk-off periods as we believe that Trump’s pro-U.S. growth policies will be supportive.

Lastly, we are neutral on the CAD at present given how much bad news is built into market assumptions at present levels. However, we will be looking for opportunities to go long the USD if we have episodes of CAD strength.



For more insights on market risks and opportunities, explore our 2025 Investment Outlook Centre.

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Performance (%)

Fund

Year-to-date

1-month

3-month

6-month

1-year

3-year

5-year

10-year

Since

inception

BMO Core Plus Bond Fund – Series F

5.6

1.7

2.8

6.7

9.2

0.1

0.6

2.0

2.1

As of November 30, 2024. Inception date November 13, 2014.

Insights

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Sources

1Bloomberg, as of November 30, 2024 (latest data before publication).

2Duration: A measure of the sensitivity of the price of a fixed income investment to a change in interest rates. Duration is expressed as number of years. The price of a bond with a longer duration would be expected to rise (fall) more than the price of a bond with lower duration when interest rates fall (rise).

3Yield curve: A line that plots the interest rates of bonds having equal credit quality but differing maturity dates. A normal or steep yield curve indicates that long-term interest rates are higher than short-term interest rates. A flat yield curve indicates that short-term rates are in line with long-term rates, whereas an inverted yield curve indicates that short-term rates are higher than long-term rates.

4Volatility: Measures how much the price of a security, derivative, or index fluctuates. The most commonly used measure of volatility when it comes to investment funds is standard deviation.

5High Yield Bonds: Corporate debt securities that pay higher interest rates than Investment-Grade bonds. High-yield bonds tend to have credit ratings of below BBB- from Standard & Poor’s and Fitch, or below Baa3 from Moody’s.

6Yield curve steepening: When the spread between short-term and long-term interest rates increases.

7Terminal rate: The ultimate interest rate level that a central bank sets as its target for a cycle of rate hikes or cuts.

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