Emerging market debt and U.S. corporate bonds are expected to be among the better performing fixed income segments through 2018, although asset returns are likely to be below historical averages over the next five years, according to the five-year outlook published by Standish Mellon Asset Management Company LLC, the Boston-based fixed income specialist for BNY Mellon.

Rising rates are expected to be the main drag on fixed income returns, according to the report, as Standish expects the U.S. Federal Reserve to begin raising short-term interest rates by the middle of 2015.  Other factors expected to lower asset returns over the period are diminishing quantitative easing, increasing regulation and global polarization, which Standish projects are likely to increase market volatility, lower liquidity and heighten geopolitical risk.

The report, Prospective Returns: 2013 to 2018, was written by Thomas Higgins, chief economist and global macro strategist forStandish, and Edward Ladd, chairman emeritus of Standish.

"Our analysis suggests that the federal funds rate will increase from between zero percent and 0.25 percent today to three percent by the end of 2018, with the two-year U.S. Treasury mirroring this rise," said Higgins.   "This would lead to relatively unattractive returns for Treasuries, when compared with EM debt, corporate bonds, and other fixed income segments."

Higgins added that a five-year outlook could help investors with a longer time frame capture distortions in the market created by other investors with much shorter time frames.

Among the other projections by Standish are:

• Normalization of monetary policy to result in higher market volatility -- Central banks in developed markets are more likely to use conventional tools such as short-term interest rates to achieve policy goals, rather than use unconventional tools such as asset purchases under quantitative easing.
• Government fiscal woes to increase credit premiums in developed markets -- While spending has been limited and tax revenues have increased in the short term, more needs to be done to bring down debt levels in relation to gross domestic product (GDP) in developed economies.
• Privatization of housing finance to raise borrowing costs for home buyers -- Implementation of mortgage finance reform could take five to 10 years, but nearly all reform proposals would limit government's future role.
• Tighter financial regulations to lower liquidity and increase transaction costs – With a goal of reducing systemic risk, the regulatory environment has become more restrictive in the aftermath of the financial crisis.
• Shale gas/oil revolution to lower energy prices -- The lowering of costs to extract oil and gas from previously hard-to-reach areas is expected to add to U.S. growth by reducing foreign imports of oil and lowering the cost of energy.
• Higher structural unemployment to increase income inequality and risk of social unrest  -- This could lead to rising social unrest in developed markets, as well as more frequent strikes.
• Weaker growth in China to weigh on global growth -- Slower Chinese economic growth could have negative consequences for countries that have become dependent on Chinese demand.
• Stubbornly high unemployment in peripheral countries of Europe to raise risk of social unrest and backtracking on debt targets – Bond holders could take haircuts and fiscal transfers might occur from wealthier core economies to the most heavily indebted.
• Multi-polar world with no global superpower to slow globalization process and increase geopolitical risk -- Slower growth in world trade could hurt those who rely most on external demand to drive their economies.
• Slowing FX reserve accumulation to lessen demand for Treasuries -- Emerging market countries are developing their own local debt markets, which could reduce demand for Treasuries and result in higher Treasury yields.