Unconstrained fixed income views: April 2025
Amid the uncertainty, attractive valuations are starting to appear.
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The past fortnight is not one we will forget in a hurry.
While the uncertainty and tumult has been disconcerting, there is a price for everything, and we believe there are assets beginning to offer attractive valuations despite the highly unclear backdrop.
We have raised our probability of a hard landing episode to 35%, but a soft landing remains the most likely outcome according to our analysis, at 55%.
Source: Schroders Global Unconstrained Fixed Income team, 14 April 2025. For illustrative purposes only. "Soft landing" refers to a scenario where economic growth slows and inflation pressures ease, allowing modest further rate cuts; “hard landing” refers to a sharp fall in economic activity and deeper 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.
Tariff impact significant, but not consistent with deep recession
For now, the situation remains extremely fluid, with possible outcomes wide and changing on a tweet-by-tweet basis.
At the time of writing, a 90-day pause on reciprocal tariffs has been announced for all countries, excluding China, that will face an increase to 145% in tariffs. However, there will be some short-term exemptions for electronics. For now, we analyse the economic impacts as they stand (i.e. 145% tariff on China, 10% for the rest), being aware that this could change again soon.
The easiest way to analyse the short-term impact on the US economy of these policies is to think of them simply as a tax, on consumers and businesses. Research by the Tax Foundation suggests the measures are the largest single tax increase we have seen since the early 1990s. This will likely hinder growth by reducing consumer real incomes, but the impact may be less severe than initially feared after ‘Liberation Day’, when larger reciprocal tariffs were announced. The current "tax hike" - estimated to be about 0.6% of GDP - is now consistent with slow growth, possibly stagnation, but not a deep recession.
While consumers worldwide will face higher costs due to tariffs, they will receive some relief from lower oil prices. Although this won't completely offset the pain of higher prices from tariffs, it is a positive factor.
For the rest of the world, these tariffs will act as a disinflationary shock, contributing to weaker growth alongside falling oil prices. Central banks may need to ease their policies more than they typically would because of lower inflation and slower growth, which could help mitigate some of the negative impacts on growth. Whether countries like China or those in the EU implement more significant fiscal support to help domestic businesses mitigate the impacts of the trade war, remains to be seen. Such measures, if taken, could be beneficial for growth depending on their size and timing.
Attractive valuations are appearing after indiscriminate selling
While current developments may not seem very positive from an economic standpoint, it's important to consider how these macro factors relate to the valuations in the market. In areas like investment grade (IG) and high yield (HY) credit we believe that the significant market movements and some indiscriminate selling have created an appealing entry point for these asset classes, though careful security selection will remain important.
Investor confidence is understandably low at the moment. However, this low sentiment provides scope for attractive returns as investors start re-engaging with the market once there is a sense of stability in policymaking.
Where are the opportunities?
Over the past few weeks on the government bond front, US 10-year Treasury yields have risen significantly compared to the levels at the end of March (meaning prices have fallen). This rise in yields has occurred even though stock market prices have dropped and credit spreads (the difference in yield between a corporate bond and a risk-free benchmark bond) have widened, indicating more uncertainty in the markets.
We have a positive view on US 5-year yields, but remain wary of Treasuries at medium and longer-dated maturities, which remain vulnerable. We hold a negative view on eurozone bonds given expensive valuations amidst significant changes in fiscal policy, particularly in Germany. From a cross-market perspective, German Bunds remain our preferred candidate to short.
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