Unconstrained fixed income views: July 2025
Staying the course: although the rhetoric around US trade heats up again, underlying economic conditions appear relatively unscathed.
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Despite a renewed focus on US tariffs, we see little reason to change our scenario probabilities significantly. A ‘soft landing’ remains our base case given continued signs of resilience in the all-important US labour market.
That said, we feel it is prudent to marginally raise the probability of our ‘no landing’ scenario to 25% given the scope for US prices to be inflated by tariffs. That’s at the expense of ‘hard landing’, now 10%.
A ‘soft landing’ remains our base case. We have slightly increased the probability of a ‘no landing’ at the expense of a ‘hard landing’
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.
Stable, but not strong
Another month passes, and it’s another month where the US labour market shows repeated signs of resilience. Job growth has been respectable – albeit far from robust – despite the uncertainty caused by President Trump’s trade policy. It’s not just in payrolls: we see signs of stability on multiple fronts, and with corporate profitability remaining unchallenged, we do not expect a material rise in the unemployment rate.
Adding to this, President Trump’s stance on immigration, together with the long-term demographic profile of the US, are other factors likely to push labour market supply growth lower in the coming quarters.
The tariff-driven price pressures suggested by business surveys are likely to be transitory. The inflationary picture emanating from the labour market remains relatively benign with wage growth slowly trending lower. This feeds into having a high probability of a ‘soft landing’.
The eurozone still showing signs of a turnaround
We continue to see signs of eurozone growth stabilising and, if anything, showing signs of improvement, with evidence of this most clearly coming from Germany. While the growth rebound in the eurozone is far from uniform at this stage, with the bloc’s largest economy emerging from its slumber, we feel the path of least resistance is for a further recovery in eurozone growth.
UK growth still lagging, but unlikely to get worse from here
Elsewhere in Europe, the UK continues to struggle. Second quarter growth looks particularly sluggish after an artificially strong first quarter, driven by tariff front-running and policy-induced support for the housing market, which ended in April.
That said, while we don’t foresee a significant rebound in UK growth given expected tax increases in the autumn, we believe we are close to a turning point. Easing credit conditions - including lower mortgage rates - together with stabilising real income growth (income adjusted for inflation), should gradually support the consumer from here.
Where are the opportunities?
We are somewhat cautious on duration (interest rate risk), particularly for longer maturity bonds. Politicians across countries – not just the US - and the political spectrum appear unwilling to address worsening long-term debt trajectories, making longer-dated assets particularly vulnerable.
In asset allocation, we have upgraded covered bonds (bonds backed by pools of high-quality loans, such as mortgages) once again to reflect their increasing attractiveness on a relative basis to the European periphery, which remains expensive in our view. Agency mortgage-backed securities (MBS), which are home loan investments guaranteed by government-backed agencies, remains our top pick in asset allocation given the spreads on offer and the low volatility.
In credit, we have lowered our outlook across the board on valuation grounds. That’s because spreads (the extra return investors get for taking on risk) are quite low historically, making them less appealing at current prices. Despite this, our view that high quality short-term bonds offer the most appealing value remains unchanged.
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