In the first half of 2025, fixed-income investors faced a challenging environment shaped by geopolitical shocks, inflationary pressures and heightened market volatility. Economic indicators suggest a growing risk of stagflation.

While hard data such as gross domestic product (GDP) growth, industrial production, employment and personal consumption expenditures continue to reflect a fairly resilient global economy, soft data such as consumer and business sentiment are beginning to signal increased caution, especially for countries with greater reliance on global trade with the United States. At the same time, inflation expectations remain high due to trade uncertainties, growing geopolitical tensions and fiscal policies.

This potential divergence between economic growth and inflation expectations poses a critical challenge for fixed-income managers about where to allocate capital when the two primary levers of fixed-income performance seem to be pulling in different directions.

In a more stable economic environment, slowing growth usually lowers inflation expectations, giving fixed-income managers a clearer playbook. With a more predictable growth-inflation dynamic, central banks are more likely to cut rates, prompting managers to extend duration, favour government bonds, add selective credit and position along the shorter end of the yield curve.

However, the current environment in 2025 isn’t typical. So far this year, we’ve observed increased uncertainty, driven by developments such as:

• Trade tensions: U.S. tariffs, global counter measures and further trade barrier threats have put global supply chains in peril and increased the risk of rising inflation.
• Geopolitical conflict: The Iran-Israel conflict, U.S. airstrikes on Iranian nuclear sites as well as the continuing war in Ukraine threaten trade routes and the stability of commodity prices like oil.
• Fiscal policy: The “One Big Beautiful Bill” in the U.S. is expected to increase federal deficit and the debt-to-GDP ratio, raising serious questions about long-term debt sustainability.

These events have contributed to increased volatility in U.S. 10-year Treasury yields and currency markets and traditional safe-haven assets such as gold and global government bonds.

Risk and uncertainty in fixed income

Risk involves things we can measure or estimate while uncertainty involves things we can’t.

• Risks such as interest rate risk or credit risk can be estimated based on historical activity, economic cycles and fundamental analysis. Fixed-income managers continually update models that incorporate these factors and build scenarios to manage risk.
• Uncertainty stems from unpredictable events such as political upheavals, unexpected central bank policy shifts or global conflicts. Diversification remains a key strategy to mitigate the impact of such uncertainty on portfolios.

In such an environment, fixed-income managers must balance their quest for yield with the downside risks of capital impairment, re-evaluate traditional strategies and look for additional sources of potential return

PSG's fixed-income strategy in 2025

To navigate this environment, Portfolio Solutions Group (PSG) has implemented three key strategies in its fixed-income portfolio construction:

1. Increased exposure to alternatives: PSG has expanded its allocation to liquid alternatives and private credit, complementing existing holdings in real estate and mortgages. These assets aim to enhance the risk-adjusted returns by providing additional sources of alpha and reducing overall portfolio volatility.
2. Reduced exposure to corporate bonds: As corporate bond spreads tightened in late 2024 and early 2025, PSG reduced direct exposure to corporate bonds, re-allocating to Canada Life Canadian Core Plus Bond Fund. This shift provides greater flexibility to adjust credit exposure dynamically through active management.
3. Active fixed-income management: In addition to the flexibility active managers offer, such as shifting allocations from corporate bonds to government bonds, they can also tactically apply strategies like duration management, yield curve positioning and identifying undervalued opportunities.

In today’s complex and uncertain macroeconomic environment, the role of actively managed fixed income is crucial. With traditional signals diverging, navigating fixed-income markets requires agility, insight and discipline.

PSG’s approach demonstrates how a diversified, actively managed fixed-income strategy can adapt to shifting conditions, mitigate downside risks and uncover new sources of return. Within PSG managed portfolios, this flexibility is amplified by using different managers to bring complementary perspectives, specialty expertise and tactical responsiveness, enhancing the ability to weather volatility and capitalize on opportunities.

Portfolio Solutions Group is a division of Canada Life Investment Management Ltd. Canada Life Mutual Funds are managed by Canada Life Investment Management Ltd. The funds are distributed by Quadrus Investment Services Ltd., IPC Investment Corporation, and IPC Securities Corporation, and may also be available through other authorised dealers in Canada. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. 

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