Australian fixed income set to shine amid global debt binge

As inflation proves sticky, long-end yields stay volatile, and fiscal concerns mount in the US, fixed income investors are facing one of the most complex backdrops in years.

And while equity markets race to new highs, two leading bond managers are taking a more sobering view, identifying where the market is ignoring risk, and where it might just be underpricing opportunity.

To unpack what’s happening in bond markets, the implications for investors, and the specific parts of the universe offering value, we spoke to:

• Kellie Wood, Head of Fixed Income and Deputy Head of Multi Asset & Fixed Income at Schroders
• Lukasz de Pourbaix, Global Cross Asset Specialist at Fidelity International

The rules have changed

Bond investors aren’t just grappling with sticky inflation or shifting rate expectations; they’re navigating an entirely new global order.

“We are living in an increasingly volatile world with episodes of risk emerging more frequently,” says Wood.

“The playbook of global investing has changed ... the key driver being bigger governments and fiscal dominance that works against central banks' inflation targets."

For de Pourbaix, it’s not just the volatility that matters. It’s the limitations in policy response if things turn south for the world's largest economy.

He notes that a key concern for all market participants is the fiscal trajectory of the US. Fidelity expects the US deficit to rise to around 6.5%, driven by a budget shortfall of approximately 3.5% and a hefty 3% in interest costs, leaving little margin of safety.

"What is underappreciated in our view is that, in the event of a slowdown, this limited fiscal headspace means there is little scope for the US government to offer any support to the economy, so any slowdown may be more severe," says de Pourbaix.

Australia vs US: A growing divergence?

Ask both managers, and they’ll tell you the same thing: Australian assets are looking increasingly attractive.

“We are more positive on the Australian bond markets vs the US for a number of reasons,” says Wood.

“Australia remains as one of the handful sovereign with a AAA rating, much of that is underpinned by the institutional stability, which stands out in an uncertain world. Debt on a relative scale remains low. 

"As inflation normalises, the cash rate is expected to come down from restrictive level which provides a positive cyclical backdrop for bond market outperformance vs the US.”

De Pourbaix says Fidelity shares a similar sentiment but is playing it differently.

“We feel that the economy is holding up better than expected. Market pricing for the RBA expects ~75bps for the remainder of 2025, whilst we are expecting fewer cuts than this,” he says.

“Our investment team behind the Fidelity Global Bond Fund’s position on Aussie bonds is relatively in-line with our global bond benchmark and we have chosen to express this view through the FX market by taking a long stance in AUD against the USD.”

A warning sign for equity markets - or just noise?

With the MSCI World Index hitting record highs, it may seem like risk is back on. But bond markets are flashing very different signals, and our two experts are split on how far central banks are willing to go.

For Wood, the message is clear: don’t expect the Fed to ride to the rescue.

"US 10-year Treasury yields are now likely to exceed US nominal GDP growth (YoY) in Q2 2025, for the first time since early 2008 or early 2011. Unless the Fed suddenly shifts to a more dovish stance, the risks of tighter policy hurting growth will persist and build," she says.

That shift, in her view, isn’t coming. 

“Spiking oil prices, tariffs, reduced immigration and high fiscal deficits could all still boost inflation later this year - the likelihood of a dovish US Fed shift looks negligible," says Wood.

De Pourbaix and the investment team see it differently. They believe a weakening economy could eventually force the Fed’s hand.

"In this recessionary scenario, cuts would need to be in the magnitude of 1.5-2% to support the economy,” he says, pointing to signs of consumer fatigue and a softening labour market.

So while both agree that bond markets are a better barometer of risk than equities right now, they diverge on the next chapter - tight policy pain with no relief, or a Fed pivot if cracks start to spread.

Where the value is hiding

Despite the uncertainty, both managers are finding pockets of opportunity, with Wood favouring local exposure.

“Australian semi-government valuations remain attractive… we’ve also increased our allocation to Australian mortgages as the RBA commences its easing cycle,” she says.

“Australian bond yields hold a strong correlation to the US, though based on the positive factors supporting Australian debt, any deallocation or diversification away from the US will benefit Australian bonds.”

Schroders also likes domestic and European credit, and is positive on emerging market debt, noting their high real yields and the backdrop of a lower US dollar is supportive.

De Pourbaix further explains that the Fund is taking a more tactical approach, combining macro views with selective credit positioning. Current allocations include:

“We have a small overweight position in senior shorter-dated bank bonds, concentrated in select issuers from the big six US banks and European national champions,” de Pourbaix says.

The Fund’s investment team also see opportunity in debt that's been disproportionately punished during recent tariff headlines.

"We have recently increased our exposure to select European autos names, as we now consider the relative value opportunity to be attractive given their credit ratings and fundamental balance sheet strength," he says.

Where they’re pulling back

Both managers share a cautious stance on US investment grade credit, citing expensive valuations and a deteriorating macro backdrop.

“We remain cautious on US-denominated assets,” says Wood. “We’ve reduced holdings to US credit both investment grade and high yield given expensive valuations and a more negative cycle.”

De Pourbaix is even more direct. 

“Valuations at a headline level are extreme and are priced for perfection, offering no compensation from a spread perspective if a slowdown scenario does emerge," he says.