Fixed income forecasts were revised slightly upwards from last year as interest rates have risen and expectations of further increases "look elevated."

Northern Trust believes that fixed income markets will continue to be driven heavily by factors such as central bank intervention, as opposed to the more typical drivers of growth and inflation. During this period of uncertainty about monetary policy, Northern Trust expects municipal bonds to remain inexpensive relative to Treasuries as financial market liquidity remains scarce.

"The outlook for fixed income investing is not as dire as some people think," Northern Trust Chief Investment Strategist Jim McDonald said. "We expect positive returns from fixed income investments over the next five years and continue to believe bonds will play a critical role in client portfolios."

Northern Trust also predicts:

• There won't be a political shift one way or the other and policies will remain stable.
   
• That asset allocation will become less focused on particular countries, with global capital markets and globally diverse companies furthering the case for a global approach to asset allocation. Northern Trust is looking at how individual assets can be combined to provide specific exposures to compensated forms of risk.
   
• Inflation remaining at subdued levels. However, financial markets may be slightly underestimating inflation risk going forward. The combination of low inflation expectations and ultra-aggressive central banks continues to argue for inflation protection within a diversified portfolio.

Each year, Northern Trust's Capital Market Assumptions Working Group develops a long-term forecast for economic activity and financial market returns that is designed to be "forward looking and historically aware." The group also identifies specific risks that are combined with other portfolio construction tools to annually review and update the firm's recommended strategic asset allocations.

The group is composed of senior investment professionals from across Northern Trust globally, including the firm's chief investment officer, chief investment strategist and managing directors of specific asset classes.