Unconstrained fixed income views: March 2025
Amid significant shifts in the global economy we see emerging opportunities on the fixed income front.
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What a difference a month can make. Arguably, the last few weeks have witnessed a dramatic shift in the narrative across the global economy. With Germany finally awakening to the idea of sizeable fiscal stimulus and the US slowing down—bringing recession fears with it—markets have moved aggressively to reflect this backdrop.
Source: Schroders Global Unconstrained Fixed Income team, 17 March 2025. For illustrative purposes only. "Soft landing" refers to a scenario where economic growth slows and inflation pressures ease; “hard landing” refers to a sharp fall in economic activity and additional rate cuts are deemed necessary; “no landing” refers to a scenario in which inflation remains sticky and interest rates may be required to be kept higher for longer.
A ‘soft landing’ remains our base case, but we have upgraded our probability of a ‘hard landing’ in response to near-term weakness. Conversely, we think the probability of a ‘no landing’ has fallen. This reflects our view that the negative growth shock from tariffs will help offset any inflationary price adjustments, in the short term at least.
The eurozone gets a wake-up call
For some time now, the eurozone has struggled with declining competitiveness, high energy prices, a downbeat global manufacturing backdrop, and, in the case of Germany, a lack of ambition to fiscally stimulate its economy.
However, a combination of increasing self-reliance for security reasons and a change in leadership appears to have catalysed a change in Germany’s fiscal backdrop.
The infrastructure and defence-led package announced by incoming Chancellor Merz represents a significant change in the level of proactivity among German policymakers. We think this could stimulate further spending in other eurozone countries or facilitate additional joint debt or loan issuance at the EU level.
In contrast, developments in the UK have taken a back seat compared to the eurozone. Weak growth would argue for a pressing need for more easing from the Bank of England (BoE), yet persistently high inflation limits their ability to ease aggressively.
While Europe looks up, the US heads the other way
The US economy is slowing, but from a high starting point, as consumers and businesses brought forward purchases ahead of potential tariffs. Recent weaknesses can also be attributed to a decline in business investment stemming from high levels of uncertainty and cold weather, which has seemed to have quelled consumer spending.
Recession fears have started to mount. While we believe these are partly justified in the short term, we don’t expect that they will persist over the medium term.
On inflation, the market remains relatively unconcerned about the risks of tariff-induced price rises. The downbeat growth outlook is likely to suppress concerns over the inflationary impact of tariffs in the near term, although it could grab investors’ attention at some point.
Where are the opportunities?
Bond markets have already responded sharply to the change in outlook. However, we would see weakness in US Treasuries as a buying opportunity. From a cross-market perspective, German Bunds remain our preferred candidate to short.
We have held a positive view on European corporates over the US based on relative valuations for some time now. However, the dramatic market moves in recent weeks, and the strong outperformance of European issuers, means that we now adopt a more neutral stance between the two. Similarly, the recent weakness of US high yield bonds (bonds rated below investment grade and that typically offer higher yields to compensate for increased risk) have made them more attractive on valuation grounds in our view.
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