Six keys to understanding the role of fixed income in times of geopolitical crisis

Fixed income is one of the main asset classes within strategic asset allocation, performing key functions such as capital preservation, stable income generation and diversification relative to more volatile assets. Although it has traditionally been perceived as a relatively predictable segment, bond investing is heavily influenced by macroeconomic variables, monetary policy decisions, geopolitical risks and issuer-specific characteristics.

Josep Maria Pon, Head of Fixed Income and Money Market Assets at Creand Asset Management in Andorra, has outlined six key factors for understanding the role of fixed income in periods of geopolitical crisis (such as the one we are facing today), which introduce uncertainty around economic growth, fiscal stability and investor confidence.

1. 1 The “flight to quality”: a safe haven in times of uncertainty

Geopolitical events are among the factors that can most rapidly disrupt financial markets, introducing uncertainty around economic growth, fiscal stability and investor confidence. Armed conflicts, economic sanctions or trade tensions can abruptly affect bond valuations. In this context, fixed income markets tend to react with particular sensitivity, as bonds are regarded as a key tool for preserving capital during periods of instability.

One of the most characteristic phenomena in such episodes is the so-called “flight to quality”. As global uncertainty rises, investors tend to reduce their exposure to more volatile or higher-risk assets and reallocate capital towards instruments perceived as safer. In practice, this often results in increased demand for government bonds issued by developed economies with strong financial standing and a long track record of institutional stability.

Moreover, geopolitical crises affect not only perceptions of issuer risk, but also expectations for global economic growth. An escalation in international tensions can disrupt trade, commodity prices and supply chains. In turn, these factors influence inflation and growth forecasts. These expectations shape the trajectory of interest rates and, consequently, the overall behaviour of fixed income markets.

• 2 The importance of macroeconomic dynamics as a driver of bond markets

Bond prices are largely shaped by macroeconomic dynamics, which are themselves influenced by geopolitical developments. Among the most relevant indicators are inflation and the stage of the economic cycle. During periods of expansion, demand for credit rises alongside inflation expectations, which tends to push interest rates higher. By contrast, in phases of slowdown or recession, investors seek out safe-haven assets, leading to lower yields on high-quality government bonds.

Leading indicators such as business climate and confidence indices, industrial prices and housing market data also provide valuable signals. Labour market trends are particularly important: for example, a sustained decline in unemployment combined with rising wages typically points to more restrictive monetary policy. Finally, financial and monetary conditions—including system liquidity and the money supply—affect the availability of credit and the cost of capital, thereby shaping the valuation of fixed income instruments.

• 3 The significant role of central banks

Central banks are the primary drivers of financial conditions and the term structure of interest rates. Their key tools include setting policy rates, conducting open market operations, providing forward guidance and implementing large-scale asset purchase or sale programmes. The relationship between interest rates and bond prices is inverse: when central banks tighten monetary policy, yields rise and prices fall.

• 4 Interest rate risk: a key challenge for investors 

Interest rate risk is particularly significant in periods of uncertainty and volatility, as it refers to the sensitivity of bond prices to changes in market yields—movements that may be triggered in a geopolitical conflict scenario, for example. However, other risks should not be overlooked. Credit risk reflects the possibility that an issuer may fail to meet its financial obligations, depending on its solvency and the broader economic environment. Currency risk, meanwhile, captures the potential impact on returns when investing in bonds denominated in a currency other than that of the investor.

• 5 Duration: a key measure for managing and protecting investments

Duration is the primary measure of a bond’s sensitivity to changes in interest rates. It is a risk metric that indicates the time required to recover an investment and allows investors to compare the volatility of bonds with different characteristics, as well as to assess it at an overall portfolio level. It also enables portfolio immunisation by aligning the duration of bonds with the time horizon of liabilities, and supports the implementation of a range of strategies, such as directional positioning (increasing or reducing duration), ladder strategies (staggered maturities), barbell strategies (a combination of short- and long-term maturities) and bullet strategies (concentration in a specific segment of the yield curve).

In the current market environment—marked by shifting monetary policy expectations and heightened economic uncertainty—duration management has become an especially relevant tool for investors. Adjusting portfolio duration makes it possible to position for potential interest rate movements, whether by reducing exposure when rate rises are expected or increasing it when monetary conditions are likely to ease.

• 6 The positioning of fixed income assets in the current environment 

The fixed income universe encompasses a wide and diverse range of assets. At one end lies the money market, which includes short-term instruments—generally with maturities of less than 18 months—such as deposits, Treasury bills and commercial paper. These instruments are typically characterised by high liquidity and relatively low volatility, which is why, in periods of geopolitical uncertainty, many investors turn to them as a way of preserving capital while awaiting greater market clarity.

Next is the public fixed income market, which comprises bonds issued by governments. Within this segment, a distinction is made between developed and emerging market debt. In times of geopolitical tension or global instability, investors tend to focus on government bonds issued by developed economies with strong creditworthiness, as these are regarded as safe-haven assets. By contrast, emerging market debt is generally more sensitive to episodes of international uncertainty, as investors perceive higher risks related to political stability, currency strength and dependence on external trade.

As for private fixed income, this includes bonds issued by financial and non-financial corporates. It also encompasses securitisations or ABS (asset-backed securities), which are bonds backed by assets such as mortgage loans, consumer credit or credit card receivables, as well as structured bonds, which combine a fixed income instrument with one or more financial derivatives. In periods of geopolitical tension, investors tend to become more selective within this segment, favouring issuers with strong balance sheets and high credit ratings.

In recent years, ESG bonds have also gained prominence. Issued by companies or governments, they are intended to finance projects that meet environmental, social and governance criteria. While their performance largely depends on the issuer’s creditworthiness, growing interest in sustainable investment has helped sustain relatively strong demand for this segment, even in more volatile environments.

Across all these markets, credit spreads—or risk premiums—play a fundamental role. This premium reflects the additional compensation investors require for assuming the risk of default by an issuer—whether a sovereign or a corporate—and is measured against a benchmark considered risk-free. In periods of geopolitical uncertainty, these spreads tend to widen, particularly for issuers with lower credit quality or reduced liquidity. Factors such as high levels of public debt, large fiscal deficits, low credit ratings, a subordinated position in the capital structure, longer maturities or lower asset liquidity can significantly increase this risk premium.

Credit ratings are another key element in assessing these risks. These independent assessments are carried out by specialised agencies such as S&P Global, Moody’s, Fitch Ratings and DBRS Morningstar, and measure an issuer’s ability to meet interest payments and repay principal. Ratings are typically grouped into two broad categories: Investment Grade, which includes issues with low to moderate risk; and High Yield, which covers higher-risk issuances but with potentially higher returns.

The impact of ratings on issuers is significant. A higher rating allows access to financing on more favourable terms and at a lower cost, while a lower rating means investors will demand higher returns to compensate for the additional risk. In periods of geopolitical tension or economic uncertainty, these differences in credit quality become particularly relevant, as investors tend to prioritise issuers with greater solvency and stability.