2025 Bond Markets: The Rise of Fiscal Policy

Monetary policy dominated markets in the last two years as inflation soared and the Federal Reserve aggressively raised rates to reign it in. Now, with inflation still elevated but much nearer Fed targets, Neuberger Berman believes fiscal policy will take mainstage next year.

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“For more than two years, bond markets have been dominated by inflation data and the responses of central banks,” Neuberger Berman wrote in a 2025 outlook. “We think a reacceleration of inflation can be avoided next year, and that central banks will settle into the dull routine of debating where the neutral rate sits.”

In such an environment, monetary policy would recede to the background, at least for the bulk of the year. In its place, fiscal policy expectations and impacts will take center stage in 2025.

Current market views reflect growth expectations under the incoming administration, as well as mixed views on inflation. Neuberger Berman believes that inflation may remain stubborn, with revised expectations of a terminal Fed funds rate around 4%.

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If new fiscal policies support a continued disinflationary environment, Neuberger Berman estimates the fair value of the 10-year Treasury yield somewhere around 4.25%. It’s likely to create a wide range, however, on expectations of elevated volatility.

“But as the attention turns to the fiscal backdrop, the volatility that has been concentrated in the short end of the curve is likely to migrate into longer-dated bonds,” explained Ashok Bhatia, CFA, Co-CIO Fixed Income, Neuberger Berman.

See also: “VIDEO: ETF of the Week: NBSD”

Position for Fiscal Policy Dominance With NBSD

In such an environment, the Neuberger Berman Short Duration Income ETF (NBSD) is worth consideration. The actively managed fund seeks to generate reliable income while providing an investment-grade, short-duration profile for portfolios.

The fund currently offers a 30-day SEC yield of 5.64% and a distribution rate of 5.61% as of November 30, 2024. Distribution rate annualizes the most recent distribution and then divides by the most recent NAV. Over the same period, the average duration of the fund was 1.87 years.

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The fund invests across a variety of sectors and bond types, including fixed- and floating-rate investment-grade bonds, both foreign and domestic. These can include asset- and mortgage-backed securities, collateralized debt obligations (including CLOs), and credit risk transfer securities.

The management team considers both qualitative and quantitative factors when selecting securities. They search for underpriced bonds, both on a sector level as well as within peer groups. While 80% of the fund is comprised of investment-grade bonds, up to 20% may be below investment-grade. When investing in these junk bonds, the fund managers seek issuers in relatively strong financial health and whose credit scores may increase.

The strategy also works to reduce credit risk through its diversified exposures.

NBSD carries an expense ratio of 0.35%.

For more news, information, and analysis, visit the Invest Beyond Cash Channel.