This will likely boost US growth but at the cost of higher inflation, large deficits and greater volatility. The US economy is currently on a solid foundation with robust growth and low unemployment. However, persistent inflation remains a challenge.

Across the Atlantic in Europe, the economic outlook is less favourable amid slow growth, tight labour markets and high deficits. The impact of US tariffs and geopolitical issues adds to the uncertainty. 

The potential for a more fragmented global economic environment, driven by trade protectionism, onshoring of supply chains and shifting demographics, may lead to divergences in economic fortunes.

As we look ahead to 2025, investors may need to consider more flexible fixed income strategies to navigate these economic uncertainties.

The long and short of it

The willingness of governments to run larger budget deficits and deregulate their economies might be viewed as a positive stimulus for growth – providing an opportunity for corporate bonds to do well.

However, this fiscal approach could introduce the risk of higher inflation, prompting a monetary response of higher interest rates. This would favour shorter-duration debt, such as short-dated corporate bonds.

Despite a historically tight yield difference to government bonds, they still offer a significant pickup over risk-free cash assets, such as money market funds, and provide meaningful interest-rate carry while held. 

For anyone concerned that policies in a specific region or country might impact economic growth without significantly lowering inflation, the level of real (inflation adjusted) yields remains attractive. An inflation-linked uplift in coupon and redemption payments also protects the holder from prolonged inflation.

They may be particularly appealing in markets like the UK, where the government's tax and spend plans – alongside a more restrictive global trade environment – could result in inflation despite disappointing economic growth.

What about government bonds?

Bigger budget deficits are linked to more borrowing and higher government bond supply. This increases pressure on term premia – the extra compensation investors need to hold interest rate risk – and long-end bond yields (yields from debt with longer tenors). 

We prefer ‘curve steepeners’ in investment-grade markets, especially in Europe – where the German yield curve may steepen. This strategy profits from the increasing difference, or spread, between short-term and long-term interest rates.

Quantitative tightening – a reversal of stimulus era bond-buying programmes – will amplify the negative effects on long-term yields from greater bond issuance, while risks to growth should support the yields of debt with shorter tenors.

Economic divergence between the US and Europe will mean regional yield differences. A stronger US economy means Treasurys may underperform European government bonds due to different central bank policies. 

That’s because the US Federal Reserve may announce fewer interest-rate cuts, even as the European Central Bank eases monetary policy to boost growth in the eurozone.

In the UK, we see potential for long-duration positioning as the market hasn't yet priced in the expected economic downturn from a weakening outlook for employment.

It may pay to be flexible

Perhaps it’s time to consider an ‘unconstrained’ fixed income strategy designed to provide a greater degree of flexibility to cope with uncertainty?

A key feature of these strategies is they’re not tied to any benchmark. This allows for a broader range of investments. 

For example, an unconstrained approach is often lower duration, making these portfolios less sensitive to rising inflation and interest rates compared to a typical high-duration credit index. 

Additionally, these strategies can adjust duration as needed and explore different markets that span a wide range of credit quality.

Final thoughts

If the economic outlook tells us anything, it’s that flexibility may be an important component of investment success in the coming months. 

Stronger US growth could lead to more risk appetite and outperformance of corporate bonds, especially shorter-dated paper.

There are also opportunities in the world of government bonds which could act as a haven for investors, should the global growth outlook deteriorate in 2025. 
 
Flexible portfolios that can nimbly adjust asset allocation and duration positioning have a better chance of navigating these uncertain times.