- Fixed Income and Global Insurance Strategist
United States, Institutional
Change
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
Key points
- We have a slight overweight view on duration and credit. Our duration view is intended to benefit from the Fed’s easing path and acts as a hedge to our pro-risk stance. We continue to see securitized exposure as the primary income contributor and believe IG corporate exposure requires an extremely selective approach focused on higher-quality issuers.
- We are relatively optimistic on global equities and favor a modest increase in exposure. Earnings are supporting higher valuations, especially in the US, while monetary and fiscal policy are stimulative and trade uncertainty has receded.
- We maintain our underweight stance on oil given our view that the oil market is likely to be in surplus this year as OPEC slows production cuts. We continue to lean positively toward gold as protection against stagflation and given continued central bank demand, but currently we see a case for taking profits and staying neutral while waiting for a better reentry point.
- A spike in inflation remains the main downside risk to markets, as it would undermine the current “Goldilocks” view of growth and inflation. In addition, a much softer US labor market could raise recession risks and geopolitics remains a risk to watch. Upside risks include reasonable US trade deals with Europe, Japan, and China, as well as concrete signs that productivity is increasing as a result of AI.
Overview
We maintain a constructive view on the US economic outlook, with our base case for growth remaining modestly above consensus. While headline GDP forecasts for 2025 have moderated slightly, we continue to see upside potential, particularly if business investment broadens beyond AI and digital infrastructure into more traditional sectors and the full impact of the One Big Beautiful Bill Act (OBBBA) seeps into growth. Recent revisions to second-quarter data underscore this possibility, with AI-driven equipment investment and high-end consumer spending contributing meaningfully to output.
Labor market dynamics remain a focal point. Immigration constraints have tightened labor supply, and we anticipate a modest rise in the unemployment rate as deferred federal layoffs materialize. However, we expect stabilization thereafter, supported by targeted fiscal measures and a resilient hiring environment. The Fed’s cautious easing cycle, anchored in a risk-management framework, is expected to deliver an additional 50 basis points (bps) in rate cuts by year end. This approach reflects the Fed’s sensitivity to emerging risks in the labor market and low-end consumer segment.
Fiscal policy is poised to play a supportive role. Tax refunds in the first quarter of 2026 are expected to bolster consumer spending, potentially contributing 0.8 to 1.2 percentage points to GDP growth. However, as noted, consumer dynamics are bifurcated. Affluent households continue to drive demand, buoyed by asset appreciation and strong employment, while lower-income cohorts face persistent headwinds from elevated borrowing costs, fading fiscal transfers, and the inflationary effects of tariffs. The average US tariff rate has risen to 18%, representing a real income shock that is expected to weigh on consumption through early next year.
Importantly, productivity trends are showing signs of acceleration. Artificial intelligence contributed approximately 30% of first-half growth in the US, and broader adoption is beginning to lift corporate margins and output. These gains are not confined to top-tier tech firms; margin improvements have been observed across a wider swath of companies, suggesting the early stages of a productivity upswing. This dynamic could prove pivotal in offsetting inflationary pressures and supporting real income growth.
Nonetheless, risks remain. Trade tensions and tariff-related inflation continue to cloud the outlook for price stability and consumer behavior. Policy volatility, particularly around fiscal legislation, adds further uncertainty. Geopolitical developments, including energy market disruptions and regional conflicts, remain potential sources of macro instability. Additionally, small businesses, especially rate-sensitive small-cap firms, continue to face earnings challenges. While recent market rebounds have provided some relief, investment trends within this segment will be a key swing factor in the quarters ahead.
Reserve fixed income: Risk-on but quality and discipline matter
We believe insurers should remain selectively risk on given the supportive macro backdrop and resilient growth, prioritizing high-quality income while preserving flexibility to add risk as valuations improve. From a sector mix perspective, we favor carry, structure, and diversification over a pure spread tightening bet. We think securitized assets should anchor portfolio income and that investment grade corporate exposure should be highly selective and biased to stronger balance sheets. As noted previously, we have a slightly long view on duration versus benchmarks, which could benefit from a potential Fed easing path and help hedge a pro-risk tilt. In parallel, we think sizing of active risk should be disciplined given still thin risk premia. We are mindful that while valuations are historically tight on a spread basis, all-in yields remain generally favorable (Figure 1) and may provide insurers with attractive carry.
Figure 1
A few sector-specific thoughts to share:
- Corporates — We maintain a modest overweight view on financials and utilities, while keeping an underweight view on industrials, concentrated in longer duration partials where valuations are least compelling.
- Securitized credit — Our preferred tilts are toward CLOs, ABS, and RMBS to potentially preserve carry and lower idiosyncratic exposure amid expected increases in M&A/LBO activity.
- High yield and bank loans — We favor measured exposure to high yield and bank loans but see a case for migrating up in quality — emphasizing BB risk and securitized substitutes where possible — to help keep carry while managing late cycle credit risks. This quality bias echoes the team’s guidance to be selective in IG corporates and to use securitized markets as the primary income contributor.
On a risk adjusted basis, return opportunities are still thin, so we favor keeping active risk in the bottom quintile of our historical range, only slightly above recent lows. We think this disciplined posture can help deliver an incremental income advantage versus benchmarks — enough to enhance yield without compromising stability.
At the same time, we are mindful of potential downside scenarios. One area of concern is the AI growth narrative: If it were to stall, that could weigh on consumption and labor markets and erode risk sentiment. Should that occur, we would expect a parallel rally in rates, with corporate spreads widening by 30 to 50 bps. We think a long duration view and quality bias could help cushion portfolios against such an outcome, providing resilience if volatility resurfaces.
In terms of the overall mix, we think the focus should be on maximizing dependable income (carry from securitized, selective IG exposure) while seeking measured beta (modest corporate overweight in durable sectors), backed by liquidity aware positioning and a slight duration cushion to mitigate cyclical or sentiment shocks. This balanced stance aims to preserve book yield support and capital efficiency while retaining dry powder for spread opportunities if risk premia rebuild.
Equities: Still a positive vibe, though valuations give pause
We continue to hold a moderately overweight view on global equities. While the post-April rally has been strong and US equities are expensive, the global earnings picture is solid — though admittedly driven by US mega caps — and the policy backdrop is supportive, as central banks are easing globally, apart from Japan (Figure 2). While questions remain regarding US tariffs (e.g., a Supreme Court ruling on their legality), much of the uncertainty is behind us and companies have mitigated some of the impact by passing on roughly half the cost to consumers or down the supply chain.
Figure 2
We continue to view AI positively, with the massive investments being made providing a near-term boost to the economy and potentially driving even more meaningful long-term productivity gains. Despite the investments required, the largest tech companies have been able to generate strong cash flows and maintain high margins.
Why aren’t we more positive given these drivers? Valuations have risen, particularly in non-US markets with weaker earnings growth, and uncertainty remains high on several policy fronts in the US and elsewhere, including around issues of fiscal sustainability, monetary policy independence, and regulatory and industrial policies.
We have moved our view on the US from moderately underweight to moderately overweight. While gains have been limited to a relatively narrow group of mega caps and large AI names, we see some signs of a broadening EPS recovery as Fed cuts support small caps and value segments. In addition, lower corporate taxes, higher levels of investment, productivity gains, and deregulation seem likely to help some of the laggards. We would see any market broadening as a positive. While the market is richly valued, that is in line with a high return on equity, and earnings are still being delivered. On the earnings side, the US is clearly ahead of other regions, with a sharp recovery in both the number and breadth of revisions across companies.
We maintain our moderately overweight view on Japanese equities. Corporate governance reforms and restructuring continue to provide a tailwind, and buybacks are at record highs (and still rising). That, combined with a relatively high dividend yield, translates to a high cash return to shareholders. This has pulled in foreign investors, who flipped from net sellers to net buyers in the middle of the second quarter. However, positioning is still not stretched. At the macro level, ongoing reflation is a positive for Japanese equities. Despite strong nominal GDP, monetary conditions remain loose. Valuations have turned less supportive as the market has undergone a rerating the past few months.
We have lowered our view on Europe from neutral to moderately underweight, mainly because of weak earnings prospects. The lack of earnings growth indicates that recent gains have been valuation-driven, which means the region is no longer cheap or unloved. Optimism around German fiscal support is justified and there should be an impact in terms of stock-level winners and losers, particularly among German small/mid-caps, defense, and infrastructure, but we think the broad market impact is likely to be limited. We also see a growing divide between Europe’s periphery, which shows stronger macro fundamentals, and the core, which suffers from challenges in key industries (such as autos) and the impact of a strong euro on exporting industries. For its part, the UK suffers from an absence of tech exposure and from its domestic economic and policy reliance. While earnings have shown signs of a recovery over the last few months, they are now weakening again.
We maintain our neutral view on emerging markets (EM), particularly after a powerful rally driven by valuation expansion. Lower US rates, a weaker US dollar, and stronger risk appetites all support EM. However, much of the move has been sentiment-driven, with earnings not improving. Even in China, neither macroeconomic nor earnings fundamentals are improving, although optimism on AI and tech innovation seems partly justified.
Sector-wise, a variety of factors — whether earnings-, technical-, or valuation-driven — are shaping our preferences, rather than any strong overarching theme. We have an overweight view on communications, staples, and utilities, and an underweight view on materials, health care, and industrials. We have a neutral view on technology and financials.
Government bonds: Divergence and opportunity
During the third quarter, fiscal concerns weighed on global developed markets and 10-year yields rose. The exception was the US, where labor market weakness replaced inflation as the dominant theme and the Fed pivoted toward rate cuts. We find overall duration a more attractive opportunity relative to cash for two reasons: 1) the combination of real yield and “roll down the curve” return is providing the potential for positive excess returns across developed rates markets, and 2) we think yields are pricing in too much negativity on the fiscal side, especially in the UK.
As we noted last quarter, central banks are generally moving toward rate cuts, but the magnitude, timing, and market expectations vary substantially, and so we see opportunities to take advantage of these regional differences within our long duration view. Our highest-conviction regional view is to be long duration in the UK, which has been the poster child for poor fiscal management since 2022, when Prime Minister Truss signed off on tax cuts combined with big borrowing, and markets revolted. Today, the term premium is higher than during the “Truss moment.” With the UK facing a fiscal shortfall and new rules requiring a balanced budget by 2029 – 2030, all eyes will be on the budget announcement in late November. The consensus is that Chancellor Rachel Reeves will present a combination of tax hikes and spending cuts equivalent to £30 billion or 0.35% of GDP a year, but we think the fiscal hole will be substantially smaller and spread out over several years through 2028.
Against our bullish UK view, we are bearish on the US, Europe, and Japan. We think the market’s gotten ahead of itself on Fed rate cuts in the US when inflation is still sticky and recession risks are low. There’s not much more cutting for the European Central Bank to do, having already delivered 150 bps of rate cuts over the past year, and we see some upside growth potential from German fiscal expansion. We maintain our short duration view on Japan, where monetary policy is accommodative, inflation risks are to the upside, and fiscal policy is likely to loosen.
Commodities: Focusing on oil and gold prices
We have a moderately underweight view on commodities driven by our view on oil, where we have a small underweight view given the rise in oil prices. With OPEC barrels returning, the demand/supply balance points to a potentially sizable over-supply. We think this makes for an attractive entry point for shorting crude, with the primary risk being the substantial negative carry drag.
We have taken off our long-standing overweight view on gold. While the geopolitical environment and the investor/central bank urge to diversify remain favorable for gold, recent momentum has taken the gold price beyond our targets and the technical setup looks somewhat fragile after the strong push higher.
Insights on alternative asset classes
While we believe privates can play an important role in insurance portfolios, we also think allocators should ensure their exposures are well diversified. Following are areas we think may be attractive, including in a gradually cooling interest-rate environment.
- Transitional real estate — In commercial real estate, demand and use patterns continue to evolve, driven by factors like the growth of e-commerce and pandemic-era changes in the way people live, work, and interact with physical spaces. Office properties, for example, have shifted from traditional layouts to amenity-rich, collaborative environments. At the same time, a period of rising interest rates disrupted long-standing financing models, creating uncertainty for owners and lenders alike. As a result, real estate assets and markets are in a state of transition, and the demand for flexible, creative financing solutions is higher than ever.
In our view, transitional lending can play a crucial role in this environment by providing loans (typically first-lien, senior secured) to institutional owners who are upgrading, leasing, or repositioning properties to maximize their value and cash flows. These loans support assets that are in some state of flux, such as physical improvements or operational upgrades. We think this type of lending is attractive because it is secured by real assets and one may be able to navigate a period of stagflation-lite in the broader economy.
- Investment-grade private placements — We think private placement investment-grade credit has the potential to deliver higher expected returns than public investment-grade markets, as well as diversification and superior covenant protection relative to publicly traded counterparts. While we do not believe that a severe turn in the credit cycle is coming, we do think the current environment is late cycle and that default rates will continue to rise gradually. We think of investment-grade private placements as a potential antidote.
A Society of Actuary Studies report (“2003 – 2015 Credit Risk Loss Experience Study: Private Placement Bonds”) found that investment-grade private placement assets experienced smaller economic losses than public investment-grade credit during the global financial crisis, based on loss and recovery rate analysis. The downside protections of investment-grade private placements often incorporate financial covenants that can trigger forced prepayment. This may help mitigate “fallen angel” risk and distressed credit movement in a portfolio, contributing to a lower loss profile relative to public investment-grade credit.
- CLO equity — While residual interest holdings, including CLO equity, have seen an increase in RBC capital charges, we still believe CLO equity is an attractive asset class that could offer strong upside potential, particularly if we experience a period of spread volatility. The term, non-recourse leverage embedded in the structure makes it particularly attractive, in addition to the fact that it is likely to produce cash flows much earlier than other private investments such as private equity. And while the RBC charge may be high for life insurers, it is generally lower for P&C and health insurers. It is also a structure that should be relatively well protected in a period of gradually lower rates driven by Fed policy.
Regulatory developments
On September 8, the NAIC’s Risk-Based Capital Investment Risk and Evaluation Working Group conducted a conference call to present their progress in CLO C-1 factor modeling. While it is still early, the results thus far are consistent with the NAIC’s Structured Securities Group views, with more senior tranches having little risk, while more junior tranches face cliff risk associated with thin, subordinated tranches. The work is expected to be concluded by Q2 of 2026, after incorporating modifications requested by the NAIC in Q1 2026 (while implementation of SSG’s modeling won’t likely occur until year-end 2026).
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