As markets navigate geopolitical uncertainties and policy shifts, fixed income investors are advised to take a cautious but opportunistic stance, prioritizing income generation and global spread in a reflationary world.

In the current market environment, investors should take a fundamentals-driven approach to asset allocation, says Jenny Zeng, chief investment officer for fixed income at Allianz Global Investors ( AllianzGI ).

Speaking at the firm’s recent fixed income webinar, Zeng urged investors to prioritize economic indicators over short-term volatility. “Investment calls are based on things that we can't see or can't analyze, so we analyze and we invest based on fundamentals,” she explained. “This is what I urge everybody to do as well."

Zeng notes that while geopolitics can create near-term market swings or long-term shifts in the global order, medium-term asset prices, typically over 12 to 24 months, are driven by core fundamentals. From a macro lens, these include economic growth, inflation trends, fiscal deficits, and central bank policies. For corporate investments, she says credit metrics, balance sheet health, and default rates are key guides.

Reflationary tilt

Focusing on fixed income portfolios, Zeng describes AllianzGI's base case as “reflationary”, where inflation picks up moderately alongside growth. In this scenario, she advises against extending headline duration in benchmarked portfolios, recommending instead to “express this further through a steepener” to capitalize on curve dynamics.

A steepener involves swaps betting on widening spreads between long-term and short-term rates.

For broader asset allocation, Zeng stresses the importance of carry and roll-down strategies.

“What's most important for a fixed income portfolio is you use carry and roll down,” she says, noting that in a reflationary tilt, risky assets perform adequately, encouraging investors to “stay invested” and remain “long risk” rather than short.

This means that in the current market environment ( a reflationary tilt with range-bound rates, tight valuations, and no strong reason to aggressively extend long-duration exposure ), the primary drivers of returns for a bond or credit portfolio should be carry ( steady income ) and roll-down ( capital gains from the passage of time ), rather than betting on big changes in interest rates, credit spreads, or curve shifts.

Zeng says with valuations tight and rates likely range-bound, high-quality credit offers attractive starting yields and resilience. She suggests modestly extending the duration to the “belly” ( of the yield curve ), or around five years, to enhance roll-down benefits, as “you are getting paid slightly more to have that roll down now”.

Globally diversified

Diversification is a cornerstone of her recommendations. Zeng stresses that true diversification isn't just adding more bonds but selecting those with low correlations.

“If you own 80 percent in the US, probably diversify to own some Europe credit, or emerging market if you still like it, and own some Asian credit as well,” Zeng advises. Euro and emerging-market bonds, she notes, have shown reduced correlation to US assets, making them ideal for core portfolios.

Overall, Zeng envisions an ideal fixed income setup as a “globally diversified credit portfolio anchored in fundamentals and structural convictions, with carry and roll down”. This structure, she argues, allows investors to “sleep at night” by providing stable income amid uncertainties.

On US rates, Zeng expects two Federal Reserve cuts in 2026, largely priced in, with treasury yields in a narrower range than last year. She expects fiscal spending to eventually steepen the curve, reinforcing her steepener bias.