Schroders: Maintains the baseline forecast for a "soft landing" of the economy and holds a positive outlook on U.S. 10-year Treasury bonds

According to the Zhitong Finance APP, Julien Houdain, Global Unconstrained Fixed Income Investment Director at Schroders, indicated that since January, the fundamental view on the global fixed income market has remained unchanged, whether it is a "soft landing" for the economy or a baseline forecast, while the "no landing" scenario—where the expectation is that the Federal Reserve will not further cut interest rates in this cycle—is a significant tail risk. However, when assessing how various scenarios generate returns, there are still many factors worth considering.

The sharp decline in oil prices is a positive signal for future inflation pressures

Schroders stated that strong U.S. labor market data and persistently low initial jobless claims indicate that the local labor market has stopped loosening and may actually be tightening again. Of course, considering that the current U.S. unemployment rate of 4% is well below the Federal Reserve's forecast for the end of 2025 (4.3%), these numbers are stronger than expected. On the other hand, the inflation data for January was strong, significantly above the Federal Reserve's target level. Therefore, the labor and inflation targets of the Federal Reserve showed unexpectedly hawkish performance in February.

Looking at these two developments individually, they make it more likely that the Federal Reserve will be unable or unwilling to cut interest rates again. However, they are not isolated factors, and several important factors need to be considered—energy, trade, and consumption. First, the strength of January's inflation was undoubtedly surprising, but there were several specific driving factors, such as significantly strong auto insurance costs, which may see some reversal in February. Other technical factors, such as residual seasonality, may also lead to sustained high inflation levels. The main indicators of inflation still appear to be good. Most importantly, oil prices have fallen sharply.

Energy prices are a crucial part of the inflation process, and this price drop is a positive signal for future inflation pressures. In fact, as long as WTI crude oil futures remain below $75, oil prices will exert deflationary pressure on overall inflation for the remainder of the first half of 2025. The lower the prices are below this level, the greater the inflationary driving force.

Trump may make appropriate concessions on tariffs; first-quarter consumption data expected to decline

Schroders mentioned that, secondly, early signs have been observed of Trump's plans to change the global trade framework. The ultimate outcome of this process is still uncertain, but it has been seen that he will take a transactional stance in negotiations, indicating that some countries may be able to alleviate or eliminate U.S. tariffs with appropriate concessions. However, it is believed that even if the current economic growth indicators remain strong, if Trump begins to interfere with the global trade environment early in his term, it will be viewed by the market as a slight negative factor for future growth. Measures to cut government spending and improve efficiency will have a slight negative impact on demand and employment in the coming months.

Finally, Schroders previously raised the possibility of an "no landing" scenario occurring, with strong consumption in the fourth quarter of 2024 being one of the considerations. However, there is evidence showing that part of the strong momentum is due to consumers making early purchases in anticipation of potential tariffs and price increases, similar to the situation at the end of 2017. If this is indeed the case, it is expected that consumption data in the first quarter of 2025 will decline, but it should be reiterated that consumption is still expected to be positive After the "overheating" of consumption in the fourth quarter of 2024, this easing situation will bring the first quarter of 2025 back to a "just right" state.

The market reflects that the Federal Reserve will no longer cut interest rates in 2025, maintaining a positive view on U.S. 10-year bonds strategically.

Schroders Investment indicates that there are already signs in the bond market showing that option pricing models have reflected the possibility of an "no landing" economy. The current market also reflects a more realistic possibility—that the Federal Reserve will no longer cut interest rates in 2025, which reduces the space for future hawkish rate cuts. In other words, as the market adjusts its view on "no rate cuts in 2025," further data showing a strong U.S. economy and/or rising inflation is unlikely to shock the market.

Additionally, the measures taken in January to ease regulations and support demand for U.S. Treasury bonds have led to cash bonds outperforming swaps rapidly. Given the market's consensus on the related measures, the improvement in cash bonds relative to swaps may continue, providing other favorable technical momentum for the cash bond market.

Based on current valuations, excessive negative sentiment, and supportive technical factors consistent with an "economic soft landing" benchmark, a strategically positive view on U.S. 10-year bonds is maintained. However, moderate targets should be set in this regard, unless or until more obvious signs show an increased possibility of an "economic hard landing," which remains a smaller tail risk at present. A neutral stance is held on the duration of European and UK bonds. In Europe, despite the economy still being stagnant, it is noted that the downward momentum has paused, and the risk of a severe recession has decreased.

The attractiveness of asset-backed bonds has weakened.

Compared to U.S. investment-grade credit, Schroders Investment prefers agency mortgage-backed securities (MBS) as they provide an attractive source of yield and performed well in January. Given that valuations remain attractive and interest rate volatility has decreased, agency mortgage-backed securities continue to be the most confident high-weight asset in fixed income allocation. Similarly, the preferred short-term European investment-grade credit performed well, outperforming U.S. investment-grade credit in January, and investment opportunities are still seen in this area. However, due to overvaluation, a cautious stance is maintained on global high-yield credit.

Schroders Investment has always had high confidence in asset-backed bonds, but as their attractiveness has weakened, this confidence has slightly diminished. A very positive view is held on French asset-backed bonds, but there are fewer opportunities in other regions at the current valuation levels. Conversely, there is an increasing potential seen in areas such as quasi-sovereign and supranational issuers.

Maintaining a moderately positive view on the U.S. dollar.

As mentioned above, in macro trading, a strategically positive view on U.S. duration is still held. However, considering the strong consensus in the market on curve steepening and some technical factors that contradict this, the view on curve steepening trades has been adjusted to a more neutral stance. This position may be re-evaluated in the coming months, but currently, a wait-and-see attitude is maintained.

Breakeven inflation has become high, and the best way to reflect this view is through eurozone steepeners, meaning that it is expected that the eurozone breakeven inflation rate will decline more in the short term than in the long term, while the longer term currently offers an attractive risk-return profile Finally, maintain a moderately positive view on the US dollar. In the newly issued bond market, try to find bonds that can provide good credit spreads to optimize returns