Unconstrained fixed income views: August 2025
Time to ease, but not time to worry about the US economy
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The state of the US labour market is closely watched by the Federal Reserve (Fed), and by global markets. Over the last few weeks there has been a significant reassessment of its health following the softer US payrolls figures in July, which were accompanied by downward revisions to May and June estimates too.
Taking this into account, we have reduced our probability of a no-landing scenario to 10% and increased that of a potential hard landing to 20%.
But while the skew of risks has changed to the downside, our strong base case remains for a benign, soft-landing environment to be the most likely medium-term outcome.
Small change in soft-landing probability; more risk now on the downside
Source: Schroders Global Unconstrained Fixed Income team, August 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.
We remain comfortable with the view that the US economy is “muddling through”, with growth that is positive even if not especially strong. We believe stabilisation from here is more likely than continued downward momentum: tariffs are impacting growth but not cratering it, and consumers seem to be taking higher prices in their stride. Uncertainty - the ultimate ‘hiring killer’ - is reducing. So we’re not currently worried about a potential US recession.
But the weaker US labour market numbers, with job gains slowing (and narrowing in terms of the number of sectors still adding jobs), suggest more vulnerability in the economy. This will impact the Fed’s willingness to ease policy faster. We don’t see justification for a larger (50bp) cut in September, but there is now scope for the Fed to reduce rates more quickly than they might have otherwise.
The outlook for longer-dated bonds in the US is less positive, however, amid concerns over US fiscal dynamics, as well as the Fed’s independence.
In Europe, the economic environment continues to improve as tariff uncertainty declines, and the European Central Bank (ECB) has made clear that they are not expecting to cut rates further. We absolutely agree with this assessment, and the signalling of this from ECB President Christine Lagarde is an important step for the European economic outlook. It suggests an underweight position in European bonds, especially given the potential impact of higher levels of issuance following Germany’s announcement earlier this year of a shift to an approach of higher fiscal spending.
We hold a more neutral view on the UK. The more hawkish Bank of England comments at the latest meeting and the resilience of the UK growth outlook means we see little reason for gilts to perform strongly in the near term.
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