Risks are evolving, but so are opportunities. Here’s how to take advantage.
The war in Iran has delivered an oil shock into a bond market that had not fully shaken inflation pressures. Higher energy prices have revived concerns about the path of inflation just as central banks were edging toward rate cuts, forcing a reassessment of what investors require to hold long-term bonds. That reassessment is now playing out in higher long-term yields and steeper yield curves globally.
As the conflict disrupted supply and raised the risk of prolonged strain around key shipping routes, crude oil prices moved sharply higher, feeding through to inflation expectations and complicating the policy path. Central banks that had been moving cautiously toward easing are now balancing renewed price pressure against softer growth, leaving the outlook for policy less certain.
But the adjustment extends beyond inflation. The shock has reinforced investor focus on large fiscal deficits and rising government issuance, particularly at the long end, where heavy supply is meeting limited demand. Meanwhile, AI infrastructure spending has lifted the market’s expectations for long-term GDP growth—and for the neutral rate—in the US. (Whether those expectations play out remains to be seen.)
Yields have risen sharply even as near-term growth expectations have softened, particularly in the US. While the oil shock has lifted near-term inflation concerns, longer-term inflation expectations have remained relatively stable. Thus, the rise in yields has been driven primarily by higher real yields, as investors demand more compensation to hold duration.
At the same time, dispersion has increased meaningfully, especially between countries that are oil exporters versus oil importers, issuers able to secure cheaper renewable energy versus those beholden to volatile fossil-fuel costs, and issuers better positioned to capitalize on the AI-driven investment boom versus those left behind.
Six Strategies to Strengthen Portfolios
In our view, these conditions call for caution even as wider dispersion across regions, sectors and companies create opportunities for investors. Active duration, global diversification, and a balance of rate and credit risks remain well suited to today’s increased uncertainty, as these strategies help position active investors to absorb volatility and capture new opportunities as they arise.
Diversify duration. In our view, today’s environment argues for keeping bonds anchored within overall portfolios—and that means holding duration. But don’t just set your portfolio duration and forget it. When yields are higher (and bond prices lower), lengthen the duration; when yields are lower (and prices higher), trim your sails. And remember, high current yields provide a cushion against price declines.
We believe that duration should also be sourced from diverse regions. A globally diversified approach to duration may offer a sturdier foundation for bond portfolios. Curve positioning, too, is a lever that shapes how portfolios respond as the rate environment evolves.
Government bonds remain the purest source of interest-rate sensitivity and remain essential for liquidity. But investors can also take duration through securitized markets such as agency mortgage-backed securities, which provide both duration and incremental yield and are generally less exposed to energy-related disruption, in our analysis.
Adopt a balanced stance. As we see it, a balanced posture across rates and credit provides a sturdier mix of resilience and income. Among the most effective strategies are those that pair government bonds and other interest-rate-sensitive assets with growth-oriented credit assets in a single, dynamically managed portfolio.
This pairing helps mitigate tail risks and diversify exposure to macro drivers. Combining diversifying assets makes it easier to manage the interplay of rate and credit risks and to readily tilt toward duration or credit according to changing market conditions.
Focus on quality credit. Since the conflict escalated, credit spreads have risen modestly off extremely tight levels but remain contained. That said, we see yield levels as a more reliable guide to forward returns than spreads alone. And yields look compelling across many credit-sensitive sectors.
Selectivity is key, in our view. Geopolitical developments and structural themes such as the AI-driven capex cycle create opportunity, uncertainty and dispersion across industries. We think it makes sense to underweight cyclical industries, CCC-rated corporates—which account for the bulk of defaults—and lower-rated securitized debt, as these are most vulnerable. Mixing higher-yielding sectors across the rating spectrum—including high-yield corporates, emerging-market debt and securitized assets—provides further diversification.
Temper equity volatility with high yield. Historically, high-yield bonds have delivered returns comparable to equities but with meaningfully less volatility—and have generally outperformed equities in periods of below-trend growth. In our view, that makes high yield a credible complement for investors aiming to ease equity volatility without materially sacrificing return potential.
Harness a systematic approach. Today’s environment also increases potential alpha from security selection. Active systematic fixed-income approaches may help investors harvest these opportunities. Systematic strategies rely on a range of predictive factors that aren’t efficiently captured through traditional investing. Because systematic approaches depend on different performance drivers, we believe their returns complement traditional active strategies.
Protect against inflation. We think investors should consider increasing their allocations to inflation strategies, given the risk of future surges in inflation and inflation’s corrosive effect.
Staying Disciplined in a Disrupted Landscape
We believe these strategies collectively create a more resilient fixed-income foundation. In our view, diversified sources of duration, balanced rate and credit exposures, and ample liquidity provide a framework that can absorb uncertainty while remaining nimble enough to quickly capture fresh opportunities as they arise.