Income resilience amidst soaring deficits

Key takeaways:

• The U.S. is running persistently large deficits, and the cost of financing them is rising, putting upward pressure on Treasury yields.
• Traditional diversifiers like long-duration bonds may no longer offer the same protection in portfolios.
• Income strategies that are diversified across asset classes and geographies may be better positioned to navigate this new macro environment.
  

For decades, U.S. investors benefited from a powerful tailwind: low inflation, strong foreign demand for Treasuries, and a dollar that reigned supreme. This allowed the U.S. to borrow cheaply and support growth without triggering market stress. But that model is now under pressure.

Today, the U.S. is running historically large peacetime deficits with little sign of fiscal restraint. At the same time, foreign appetite for U.S. debt may be softening, especially when currency-hedged Treasury yields potentially look less attractive than their global peers. The result? A world where the U.S. may still want to run large deficits but can no longer do so at low interest rates.

With current budget deficit as a % of GDP near or exceeding prior recessionary levels and the changing relationship between equity and bonds returns, the old rules for income investors may no longer apply to the same extent.

Treasury issuance likely to continue “as far as the eye can see” with current budget deficit as a % of Gross Domestic Product (GDP) near or exceeding prior recessionary levels

This shift matters for income investors. As yields rise, the traditional role of Treasuries as a portfolio stabilizer is being challenged. While higher rates may seem like a gift to income seekers, we believe they come with greater volatility and more selective opportunities. The historically inverse return relationship between stocks and bonds has also been challenged in recent years.

1-year rolling correlation of returns since 2000 (S&P 500 and U.S. 10y Bonds)

Correlation in this context indicates the strength and direction of the relationship between the S&P500 and U.S 10yr Bond returns. Negative correlation implies when one of the indices is performing well the other isn’t, positive is when they perform in tandem (negative or positive).

“In uncertain times, it’s not about predicting the path, it’s about preparing for the possibilities.” – Justin Christofel - Co-head of Income Investing for BlackRock’s Multi-Asset Strategies & Solutions (MASS) Group

We see three potential paths forward:

1. A “kick the can” scenario where deficits persist and yields grind higher;
2. A productivity boom that helps grow our way out of the deficit;
3. Or a more disruptive correction that forces fiscal reform.

Potential Scenario Outcomes

How our views are driving our allocation changes

In alignment with our base case scenario of "Kick the Can," the Q3 2025 portfolio rebalance reflects our team’s constructive outlook.

1. We are overweight with respect to equity exposure while expressing a preference for U.S. dividend growth stocks tactically rotating from international positions.
2. In fixed income, we have moved to an underweight in duration, emphasizing high-quality credit and carry over high yield, given rising fiscal concerns and sticky inflation.
3. We are leaning into our positive view on global infrastructure to seek long-term growth opportunities tied to AI-driven capital investment, an allocation that we believe supports both income generation and structural trends.

The fiscal landscape is shifting, and income strategies must evolve accordingly. By combining equity income, credit-sensitive assets, and defensive fixed income, our multi-asset income approach is designed to stay flexible, resilient, and income-focused. It is positioned to navigate uncertainty while remaining focused on capturing opportunity.