Unlocking markets: 2025 – tariffs, tech and U-turns

Unlocking markets: 2025 – tariffs, tech and U-turns

Mark Dowding, CIO for our BlueBay fixed income platform, and Mike Reed, Head of Global Financial Institutions

Mike Reed 00:04

Hello, and welcome back to Unlocking Markets, our RBC BlueBay podcast series where we bring you our experts from across the firm, providing their opinions on the macro environment, and discussing how top-down themes help influence the way they invest. I'm Mike Reed, head of Global Financial Institutions. Today, we are welcoming back Mark Dowding, the chief investment officer for the RBC BlueBay fixed income platform. Mark is well known for his in-depth knowledge of global fixed income markets, so I'm very much looking forward to hearing his views as we head into 2026. Welcome back, Mark. Great to have you on the podcast again.

Mark Dowding 00:41

That's great. Thanks very much, Mike.

Mike Reed 00:44

When you were last on the show at the end of 2024, President Trump was just about to begin his second term, and you predicted, in your words, that this would usher in an era of chaos and volatility. Wow, how right you were. You also thought, contrary to the consensus, that US growth remained robust, and the Fed would not cut interest rates aggressively in 2025.

Instead, you reasoned they would go on hold for a prolonged period whilst they reviewed the incoming data, which they subsequently did. Obviously, I must compliment you on such good calls at the end of last year, but with so many moving parts, what is your view on US growth right now, and how are you positioning your portfolios to benefit from this?

Mark Dowding 01:26

It's been quite a year, hasn't it? Thanks for the recap, Mike. Look, going forward from here, I think the thing that really strikes us is the US economy continues to be in good shape. We've actually seen pretty robust growth during the course of 2025. I think one of the prevalent themes, of course, has been the amount of investment going into tech and into AI, more specifically. In this regard, I think the analysis suggests that the total volume of AI spend in the US next year is going to rise from USD75 billion in 2025 to USD300 billion in 2026.

Now, with that much money being thrown at the economy, that creates a strong tailwind for growth. Add on some tax cuts, some rate cuts, some deregulation, and we think you could be looking at a US economy that's growing above 3% in the course of the year ahead, so an acceleration, not a slowing down. At the same time, risks to inflation seem more on the upside than the downside.

We haven't had the full pass-through of tariffs into inflation just yet, and so it could be a year where we see relatively robust nominal growth. That being the case, I would suggest to you that we're not looking for much in terms of rate cuts during the course of the year ahead. We may well see one last cut in December by Jay Powell, but thereafter, I think things probably go quiet in terms of monetary policy. And I think that longer-dated bond yields are also more likely to trade in the range. And I'd infer, in many respects, the current level of yields, the current level of interest rates, these are what I regard as normal levels of interest rates. Perhaps, along with yourself, Mike, we started our career long before the financial crisis of 2008. We're not in the generation that have grown up since, thinking normal interest rates were 1% or 2%. It seems that we're back to the normal very much now, isn't it?

Mike Reed 03:27

Yes. I think we have both been in the markets for, let's say, just a couple of decades, shall we say.

Mark Dowding 03:33

I guess I'd go on from that. In terms of your question, in terms of how we're positioning, therefore, I'd say that with the economy looking pretty robust, I think that recession risks are low. When recession risks are low, credit does fine. We've seen credit outperform in 2025. I think, for the time being, credit can continue to outperform, albeit I don't think you're going to see much more credit spread compression. It's more of a year where you could be investing for carry, investing for yield, more than really trying to extract capital gains.

Particularly with spreads being tight and abundant issuance, effectively, that move, tighter in spreads, starts to run out of road. You still have corporate bonds, we think, outperforming government bonds and cash. Otherwise, I think that when it comes to macro investing, it's more a year about trying to play the ranges, trying to identify where to buy, where to sell. I think the last thing that I'd lay in, as I was earlier this year, although this sounds like a fairly benign environment, I don't think it's going to be a quiet year. There's almost certainly going to be some speed bumps along the road, and those speed bumps will always offer an opportunity.

Mike Reed 04:48

We'll come back to the carry thing later, because I want to ask you about that, because that's important. Touching on what you've talked about there as far as governments and corporate, because you talked a lot about corporate debt there, we are very much in a world of high government bond supply and large fiscal deficits. This is definitely causing some concern with – I've heard from several market commentators, around the long-term sustainability of government finances, particularly in the US, UK, and France. How well are markets actually absorbing this surge in supply, and do you share the worries about debt sustainability, particularly in those countries?

Mark Dowding 05:23

Look, I think the idea of there being a worry around debt sustainability won't go away when you're running such high levels of government deficit, when you're running such a large amount of government debt. We're in a world where an ever-growing portion of tax revenues is being absorbed in terms of debt financing costs. So that's a real problem that we're trying to get our heads around. That said, if I think about the US, although their deficit is way too high, the truth is that in the course of the year ahead, that deficit is actually starting to come down a bit, thanks to the fact that the US is collecting now around about USD400 billion of tariffs.

Even if they vote down the IEEPA tariffs, imminently, we'll see these replaced with other sorts of tariffs, won't we? They've effectively become a de facto tax increase in the US, akin to a consumption tax which exempts domestic production. The US deficit is coming down a little bit, and so we could see a five-handle on the US deficit in 2026. Bear in mind that if you've got, let's say, 3.5% real growth, 3.5% inflation, that could be 7% nominal GDP growth.

From that point of view, if your deficit is lower than your nominal GDP growth, at least your debt-to-GDP ratio isn't climbing. Where debt sustainability becomes a bigger problem, though, is where you've got no growth. In Europe, that's clearly more of a problem. Yes, France is a country that continues to live beyond its means. I think it will have, at some point, a moment of reckoning that society needs to embrace the fact that this cannot continue to be the case on an indefinite basis. It's already now the weakest sovereign credit in the context of the Eurozone, and so it is on a structurally deteriorating path.

As for the UK, I think that the debt levels, frankly, are lower in the UK. The problem, in my mind at the moment, is we've got a government trying to address this shortfall in finances by sticking taxes up, which is just damaging growth, when actually what they should be doing is doing some measures to actually get on top of runaway welfare spending and starting to clamp down on more of a breeding benefits culture that's taking hold in our society.

Mike Reed 07:46

Yes, it doesn't necessarily feel that good to be in the UK right now. Looking away further afield, amongst a year of what I would say is left-field events, one that stands out to me particularly was the election of Sanae Takaichi as the first female prime minister of Japan. I don't think that was anything anybody predicted a year ago. The Bank of Japan also stands out. It is the one major central bank that is actually raising rates while others have been lowering them. Given Japanese investors are obviously so influential on the global stage, is this dynamic likely to have a major impact on worldwide capital flows?

Mark Dowding 08:22

Yes. Look, I think events in Japan do have a global significance. Of course, for a long time, we've seen a world where the Bank of Japan was buying the Japanese government bonds. Now that they've stopped those purchases, it means that more domestic money in Japan is having to support its own bond market, which means less money being circulated into overseas assets. That's something that I think is effectively impacting other global assets. Alongside this, I think the other interesting dynamic is the one where now for the last three years, we've seen Japanese inflation hover around 3% above the Bank of Japan target, but all the while, the Bank of Japan has continued to run very easy monetary policy.

Under Takaichi Sanae, the new prime minister, she's committed to getting the Bank of Japan to continue to run easy monetary policy, and also deliver relatively relaxed fiscal policy, and have something of agenda where she wants strong nominal growth to actually exceed bond yields, which is a rather risky thing to be saying if you think about it. Effectively, what she's saying is she's hoping to inflate away the value of the Japanese debt pile and bring down debt to GDP in this way. From that perspective, that makes me quite cautious as a bond investor. I'd also say that for all the weakness and the structural undervaluation of the Japanese yen, which makes this the place where I'm going to be very happy to go and do my Christmas shopping this year on an upcoming business trip that I have…I have the order from the family as to what I need to go to the stores to go get buying...but I think that you would observe that it's going to be difficult for that yen to rally until such a time that monetary policy normalisation is taking place and you get more of a return to policy orthodoxy. So, Japan could be a volatile story in the months ahead; certainly, I'll agree, one to watch.

Mike Reed 10:30

If I receive a sushi-making set in the office Secret Santa this year, I'll know who's given it to me! Circling back to something you touched on briefly when we started talking today, it was on the carry element. This year, we've seen a general steepening of yield curves as the yields on shorter-dated bonds have basically outperformed those with longer maturities. However, the yields on longer-dated bonds remain at an elevated or normalised levels, compared to those available in the last 15 years following the GFC. How important is the carry element now to investors within overall fixed income returns, and have you seen clients looking to increase their exposure to bond funds?

Mark Dowding 11:13

Yes. Here I'd say that you have seen more term premium coming back into markets, partly reflecting the heavy debt issuance from governments around the world, which is creating some of those concerns around sovereign credit and debt sustainability that we were previously discussing. I think the other thing that I'd say, pretty profoundly as a seasoned fixed income investor is that over the course of the past 10 years or so, there's been quite a big structural shift in terms of what many investors are looking for when they're actually investing in fixed income.

10 years back there was a strong intrinsic demand for owning duration to match assets to liabilities. That's obviously something that was a facet of pension fund investors, but many of those pension funds, the defined benefit pension funds, they've now closed, or schemes have already completed an asset liability matching schema, and that's now in place. We've seen regulatory changes, for example, in Netherlands, the Dutch pension fund reforms have taken away a big buy of long-dated bonds from that particular market. Demand for duration has been going down, but at the same time, there has been more of a demand for yield.

Again, I can think 10 years back in a European audience, I still remember the time with one of our sales colleagues, Mike, I stood on a platform and I was giving a sales pitch on one of our strategies. I said, "Please invest in our fund in the year ahead. I can guarantee that I'm going to lose you money. However, I will be losing you less money than the next guy," because the honest truth was that we had a moment when yields were below zero. It was completely bonkers. You knew that there was no value at all in public market fixed income. The risk-free return had become a return-free risk.

In this particular moment, it was understandable that people were questioning what they were doing in the asset class. Now, with yields coming back, we see more demand for yield, more demand for owning carry. That's meant more demand for owning credit. That's a trend that I think that we think remains established. Look, if we can earn and we can deliver 5%, 6%, 7% returns through owning fixed income, these are returns which are ahead of cash. In many respects, the whole raison d'être of owning fixed income has gone back to the whole idea of owning the fixed income.

Mike Reed 13:58

I agree. With rates at, say, 2%, 3%, 4%, and delivering 5%, 6%, 7%, that is a much more attractive proposition. I think we've observed that a large amount of sales are cash-based products over the last few years. I think many investors are having to dust off and actually learn actually about bond funds and getting exposed to them for the first time. Those are the people who maybe join the market maybe later than us.

But...I'm trying to be the Grinch now…while the overall macro backdrop remains supportive, as you said, for high-quality credit, there is now an increase in divergence on the performance and health of some different sectors and individual issuers. Notably, we have witnessed the high profile bankruptcies in the US auto sector, with both First Brands and Tricolor filing for protection. This has raised some concerns that we are seeing a repeat of the pattern that led to the US housing crisis in 2007-2008. Would you say this is a legitimate concern, and how important is active credit selection in your investment process?

Mark Dowding 15:02

Here, I would push back on the 2007/'08 metaphor and Jamie Dimon and his cockroaches analogy. I think that these couple of instances you highlighted were more examples of fraud. They've got more to do with Enron and Parmalat than what we saw in the early '90 in that respect, rather than something that I think is systemic within the credit market. However, I would say that in looking at credit markets, look, high-quality credit looks fine. Even high yield credit looks fine, in a year where growth on both sides of the Atlantic is likely to be a bit higher than it was this year. Yes, we'll see defaults going up, but they're coming up from a very low level.

Where we have more concern is in private markets because here you have much more leverage. Private markets, private assets work if you have really low interest rates, because you need multiple expansion and really cheap leverage. That's why the private asset community is desperate to see interest rates back to where they were at 1% or 2% in the last decade. This is the whole premise of being in private markets. Otherwise, things like private equity can end up becoming stranded assets. When you end up with highly levered companies, you can end up in the private debt space with effectively all your free cashflow being eaten up in debt servicing costs.

From that perspective, it is a space where you do see higher defaults. Defaults are currently running at 5.5% and on a rising trajectory. That's an area of the credit market to be more careful, or if you're investing in private markets, look in the interesting niches. Don't look in the vanilla funds that aren't going to give you any material premium for owning illiquidity compared to public market debt. Look in areas like distressed and stressed credit, such as our strategies in that space, or emerging market illiquid credit. Again, it's another area that I'd highlight that I think is way more exciting. Otherwise, if you're looking in public market credit, subordinated financials, they're still cheap, financial risk in Europe is still mispriced. Also, we think that high-quality CLO tranches, again, are still too cheap. I can still point to assets that do look cheap in an otherwise fully valued market, Mike.

Mike Reed 17:29

Thanks, Mark. There are obviously so many different dynamics in the global markets. I greatly appreciate you returning to the show to share your views once again. It sounds like the markets are full of dispersion right now, which should throw up plenty of alpha-generating opportunities for you and your team. Hopefully, this will lead to strong returns for our clients.

I started the show congratulating you on your accurate forecast for certain events this past year, but I don't recall you predicting that Spurs will win a European trophy in 2025 or that Chelsea will be crowned world champions. Let's see if markets throw up similar surprises next year to those that occurred in the football world this summer. Thank you, Mark.

Mark Dowding 18:07

On that note, I was just thinking about bubbles, Mike. I was wondering whether it'll be the year it all bursts for West Ham as well. That could be a sorry ending come the middle of next year when the bubble bursts. Otherwise, for the other London clubs, for Chelsea and even Spurs, I'll begrudgingly wish you continued success if we can have a trophy too. Let's see.

Mike Reed 18:35

Sorry, West Ham, but I don't think that would be defined as a left field event. There's not a black swan there. I think that's a possibility. Anyway, thanks, Mark. Many thanks for listening to the show. If you've enjoyed it, please like and subscribe on your podcast platform of choice.

We will be back in the new year, when we will be joined by Polina Kurdyavko, our head of emerging markets fixed income. With emerging markets predicted to contribute more than two-thirds of global economic growth over the next decade, the dynamics in their economies are becoming increasingly important to investors globally. Please join us to hear Polina's views.

If you wish to listen to any of the previous editions of the Unlocking Markets podcast, they are also available on our website, www.rbcbluebay.com, or can be found on Apple, Spotify, or Google. Thank you once again for joining us today. Good luck and goodbye.