Morgan Stanley IM: 2025 Global Fixed Income Outlook

Here you can find the complete article

As we enter 2025, the fixed income landscape presents a complex interplay of macroeconomic conditions, sector-specific dynamics, and geopolitical uncertainties. The post-pandemic world is markedly different: inflation (excluding China) remains generally high, while economic growth (excluding the US) is relatively low. Monetary policy is tighter than pre-pandemic levels, while fiscal policy is easy—perhaps even too easy. Additionally, politics has gained prominence; the election of Donald Trump in the US caps off a series of leadership changes in the Western world, with every G7 nation having changed leadership except Italy, which did so during the pandemic. This new landscape will influence bond market behavior in the coming year.

Throughout this outlook, we aim to provide a comprehensive analysis of anticipated trends in fixed income markets, highlighting key areas of opportunity and caution for investors. We will discuss our views on economic conditions, bond yields, credit markets, currencies, and the major risks we believe may arise in the year ahead.

Economic Conditions and Bond Yields:

We expect the U.S. economy to experience solid growth in 2025, primarily driven by the current productivity boom and resilient consumer spending, while Europe is likely to face more subdued economic conditions. The AI boom and the associated investment requirements in both the tech and energy sectors should not be underestimated. Emerging markets present a heterogeneous landscape, offering both opportunities and challenges, particularly in light of potential U.S. trade policies under the Trump administration.

In the U.S., we anticipate growth to remain robust. One of the biggest uncertainties for 2025 is how aggressive the incoming U.S. President Trump will be. Tariff increases, depending on their size and comprehensiveness, are likely to be inflationary and detrimental to growth (as observed in 2018/2019), as will reduced immigration. The market currently does not expect a full implementation, which justifies the positive reaction to his election. The negative impact of tariffs and immigration restrictions (which can be seen as a negative supply shock) may be offset, at least to some degree, by other policies expected to benefit the economy. For instance, we anticipate that supportive fiscal policy, which is currently driving investment and contributing to a productivity boom, will continue to promote strong non-inflationary growth. Market deregulation, including in the energy sector, could also prove disinflationary. Furthermore, household, and corporate balance sheets should remain robust, and a strong labor market will support consumption. Overall, we believe medium-term growth is likely to be strong, but the sequencing of policies and the response of other countries will be crucial in understanding the dynamic interplay of growth, inflation, and Fed policy responses. With growth in 2025 expected to be solid, Fed rate cuts are likely to be smaller (market pricing has correctly adjusted in the last few days of the year) than in 2024.

In Europe, we expect more subdued growth; 2025 should see growth centered around 1%, a meaningful improvement over 2022 and 2023. The manufacturing sector is likely to remain a drag on fixed investment, but a strong services sector will help compensate, supported by a rebound in household consumption that is unlikely to be robust enough to drive significant economic upswing. Additionally, the threat of U.S. tariffs, the ongoing implications of the Russia-Ukraine war, and the China’s economic slowdown have led markets to increase the cumulative easing expected from the ECB. This contrasts sharply with the U.S. bond market, which has significantly reduced the amount of easing anticipated from the Fed moving forward. We expect the ECB to cut rates at least as much, if not more than, the Fed in 2025.

Globally, economic growth is projected to be solid, with estimates between 3.0% and 3.3%. We believe China’s economic growth will stabilize, if not improve, in 2025, supporting a positive global economic outlook. Despite facing trade uncertainties and geopolitical tensions, the global economy is expected to benefit from coordinated monetary policies and improved consumer sentiment across various regions. All central banks, except for Japan and Brazil, are easing policy, which bolsters the economic outlook. This backdrop will significantly impact managing inflationary pressures worldwide.

Regarding interest rates, we believe U.S. yields are likely to remain range-bound in the coming year as markets attempt to decipher the true state of the economy—considering solid growth, a stable unemployment rate, and gently declining inflation—as well as the likely scale of the incoming administration’s policies. Some central banks, like the ECB and the Bank of Canada, may accelerate rate cuts, while others, such as the Bank of Mexico and various emerging market central banks, may pause or slow their rate-cutting in response to ongoing uncertainty and dollar strength. One of the biggest risks to this benign outlook is how firmly the market holds onto it.

We remain agnostic about the near-term outlook for U.S. yields, anticipating a range of 4% to 4.75% for the U.S. Treasury 10-year, with rate cuts unlikely to exceed those currently priced into the markets. Given that and lack of term premium in the U.S. yield curve we continue to avoid longer-duration bonds. Aside from Japan, we are neutral on duration in developed markets overalland retain curve steepening exposures, particularly in the U.S. Cross-market, we remain underweight U.S. duration compared to New Zealand, based on economic and monetary policy outlook differentials. We also maintain an underweight position in Japanese government bonds and are long Japanese inflation breakevens, as we believe Japanese inflation is structurally moving higher, prompting the BoJ to raise interest rates more than the market currently anticipates. At this time, we do not believe portfolio risks should tilt toward taking on above-normal interest rate risk, as credit sectors appear more rewarding. However, from a longer-term perspective, nominal and real yields in most countries are high by historical standards, suggesting that investors with a longer-than-one-year horizon may find that even a buy-and-hold strategy can yield rewarding returns if executed correctly with the appropriate fixed income sectors.

Here you can find the complete article

^{There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.}

^{A separately managed account may not be appropriate for all investors. Separate accounts managed according to the particular strategy may include securities that may not necessarily track the performance of a particular index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment managers, please refer to Form ADV Part 2.}