Unconstrained fixed income views: June 2025
Unchanged Melody? Despite significant global geopolitical developments, there has been no real change in the underlying economic story.
Autheurs
While there has been significant newsflow following our latest update a month ago, our outlook remains unchanged (of course, we will continue to observe events in the Middle East closely).
As we sift through the economic data we have received in the past month, we see little need to change the probabilities we assign to our scenarios. We continue to see a soft landing as the likeliest outcome (65%), where the economy slows gradually without falling into recession. Then we see a slight skew in favour of no landing (20%), where the US Federal Reserve (Fed) is unwilling or unable to cut interest rates at all in 2025, versus the risk of a hard landing.
Our probabilities remain unchanged since last month
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.
Muddling through
How have we got to this conclusion? Let’s start with the US economy, which is still the bedrock of global financial markets.
Broadly, the economy has performed in line with our expectations – official data from April and May has softened, but hasn’t been disastrous, while sentiment data has improved.
The labour market remains stable, while inflation data is yet to truly reflect the impact of price rises from tariffs, and, so far, this has been well contained.
Where do we go from here?
Though the uncertainty created by US government policy is dampening growth, we remain comfortable with the view that it will continue to expand at a decent, if unspectacular, pace; not too hot, not too cold.
In no small part this is due to the unlikelihood of a sharp slowdown in consumer spending given strong real income growth (that’s income adjusted for inflation). This has primarily been driven by increased government fiscal support. While this is detrimental for long-term debt sustainability, in the the short-term it is a supportive factor for consumption and therefore growth.
What could change this?
As ever, a meaningful weakening of the labour market remains the key factor that would prompt increased concern about the growth outlook. We will continue to monitor labour market data closely – paying particular scrutiny to jobless claims, which have been rising recently.
The end of the line
In the eurozone, the main development over the past month has been the aknowledgment from the European Central Bank (ECB) that we are nearing, if not already at, the end of its interest rate cutting cycle. We feel that the justification for further interest rate cuts is limited, given improving growth across the region and increasingly supportive fiscal policy (particularly government spending).
Meanwhile, in the UK we are seeing clearer signs of a slowdown in the labour market, as well as a cooling of underlying inflation pressures, such as wage growth. We think the market’s expectations of a comparatively higher terminal rate (the interest rate at the end of the current cycle) in the UK offers opportunities, as we anticipate some convergence with other major central banks.
Where are the opportunities?
We continue to have a neutral stance towards overall duration (interest rate risk). Instead, we favour curve steepening trades in the US, being positioned for shorter dated bonds (5-year) outperforming longer-dated bonds (30-year).
We also favour cross-market opportunities – for example, long gilts against Canada and Germany.
In corporate credit, following strong positive performance, we have downgraded our score for US CDX high yield (credit default swap indices), as the valuation argument has diminished.
We maintain a negative score on overall investment grade (IG) given expensive valuations, but remain more positive on shorter-dated securities within this sector.
US agency mortgage-backed securities (MBS) remain our top pick in asset allocation as they continue to offer comparatively higher yields and lower volatility versus US IG corporates.
Subscribe to our Insights
Visit our preference center, where you can choose which Schroders Insights you would like to receive.
Autheurs
Topics