Despite the volatile market conditions from the US-led tariffs, geopolitical tensions, stretched valuations and a “gradual rebalancing of global financing and military power”, Andrew Jackson, head of fixed income at Vontobel, believes that at these levels, alpha is “worth far more” than beta.
Alpha refers to the excess return on an investment after taking into account market-related volatility and random fluctuations while beta measures the volatility relative to a benchmark such as the S&P500.
“In our last quarterly publication, we highlighted the limited potential for short-term beta returns from fixed income, and we emphasised the significant alpha opportunities that we anticipated. The events of the past quarter could not have validated that prediction more accurately,” Jackson explains in Vontobel’s quarterly fixed income report for the month of June.
The bank’s fixed income team has since “benefitted significantly” from maintaining the view that alpha is preferred, with its flagship and highly active portfolios delivering “incredibly strong” risk-adjusted returns even if markets have returned to the same levels as its last publication, he adds.
Even though the US-led tariffs led to markets falling, the reaction was a “risk-off” event.
“Correlation across asset classes trends towards 1 (perfect positive correlation), liquid assets experience the sharpest sell-offs (in the initial phase), historically higher-beta asset classes are disproportionately impacted (even if their fundamentals have improved), and panic sets in,” Jackson explains.
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In the few weeks since, the markets have fully recovered from their losses.
“Some may interpret this as evidence that the sell-off was a ‘dip buying opportunity.’ Others may believe that current market levels are justified, even though the global economy is demonstrably and undoubtedly on less stable footing,” says Jackson on his call to focus on alpha.
“We are confident that markets are irrationally complacent about downside risks,” he adds. “We are equally confident that the path forward for US foreign and trade policy will not be a straight one. This leaves us certain that further volatility lies ahead—an environment of ‘rich pickings’ for skilled, genuinely active managers.”
See also: Trump threatens 35% Canada tariff, floats higher blanket rates
Emerging markets to take advantage of the de-dollarisation
Emerging markets can take advantage of de-dollarisation amid market dislocations created by US trade policies, according to Vontobel’s emerging market debt strategist and portfolio manager, Carlos de Sousa, with hard-currency sovereign and corporate spreads rebounding significantly since Liberation Day.
While hard-currency sovereign spreads have since recovered to pre-crisis levels, emerging market corporate and single-B rated credits remain attractively priced.
“Emerging market spreads remain significantly wider than their February lows, which were below historical averages," says de Sousa.
“A prolonged dollar decline would, in our view, significantly boost sentiment toward emerging market assets, particularly local-currency bonds,” he adds.
Emerging market local-currency bonds a clear alpha opportunity
Emerging market local-currency bonds have significantly outperformed in 2025, achieving a total return of more than 10% in just over five months (in US dollars), making it one of the top-performing fixed income assets year-to-date.
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Entering a US dollar bear market creates a highly attractive backdrop for local currency debt, which benefits from dollar weakness and looser US monetary policy. Vontobel believes that emerging market bonds, which have previously been viewed as a risky proposition, now present a clear alpha opportunity.
The imposition of border tariffs resulted in emerging market spreads widening sharply.
Spreads of oil-exporting countries like Angola, Cameroon and Gabon are 125 basis points - 200 basis points wider, with Nigeria about 50 basis points wider compared to end-February levels due to lower oil prices.
However, these countries do not face significant short-term default risk. Angola, for example, has ample foreign exchange reserves and could obtain an IMF program if needed, allowing it to “stay out of the markets for an extended period,” writes de Sousa.
The countries’ wide spreads “generously” compensate for the associated risks, the analyst believes.
Interest rates and inflation outlook
The second half of 2025 may seem “comparatively calm” after the past few months of uncertainty, says Daniel Karnaus, portfolio manager of fixed income at Vontobel.
“Similar to the Fed, we also do not yet see the risk of rising inflation as averted, given the backdrop of significantly higher tariffs and ongoing deportation of undocumented immigrants. At the same time, we do not expect a recession, even though the rising price levels due to import tariffs represent an additional tax burden on US consumers,” Karnaus writes.
This year, Karnaus expects to see a “minor fiscal impulse” from the Republican budget package, which was passed by the House of Representatives’ Budget Committee.
“With the current version of the bill, the budget deficit for 2025 and 2026 should remain unchanged,” he writes. That said, there are expectations that the Senate will make amendments and as such, a higher budget deficit for 2026 cannot be ruled out.
“This, together with Moody’s downgrade of the US country rating, could lead to higher borrowing costs, which would also inhibit growth,” Karnaus warns.
Inflation is set to exceed the US Fed’s 2025 forecast of 2.8%, potentially peaking above 3% due to tariff pass-through effects.
Weak economic growth in the third and fourth quarters of 2025 could incentivise the US Fed to further cut interest rates, likely in September, on the condition that there are no second-round effects on inflation.
“We expect the Fed funds target rate to be at 4% and the 30-year US treasury yield at 4.75% by the end of the year,” Karnaus predicts.
Uncertainties resulting from US president Donald Trump’s trade policy will ultimately affect Europe too, as Vontobel predicts that China would sell its exports that can no longer be sold in the US to the rest of the world, sparking disinflationary pressures.
It is likely that the US economy is likely to weaken compared to the rest of the world, causing capital to flow away from US assets.
Emerging central banks have room to ease
As US inflation from tariffs is perceived to be disinflationary for the rest of the world, emerging central banks have room to lower interest rates.
This results in lower refinancing costs, higher investment, stronger growth, and rising bond valuations.
As such, emerging market local-currency bonds provide a unique opportunity for investors to capitalise on, de Sousa believes.
“A prolonged dollar decline would, in our view, significantly boost sentiment toward emerging market assets, particularly local-currency bonds,” he says.
At this point, the US dollar appears to be “overvalued” based on measures of purchasing power parity and the real effective exchange rate even after this year’s observed depreciation, de Sousa adds.
“This overvaluation is attributed to the US experiencing significantly higher inflation than its trading partners since the pandemic,” he explains. “While elevated nominal interest rate differentials have bolstered the dollar in recent years, the accumulated inflation differentials must eventually be addressed; otherwise, they would lead to a further widening of external imbalances. Given the expectation of relatively higher inflation in the US and a diminished growth advantage compared to other developed markets, an exchange rate adjustment seems to be the most likely outcome.”
