In recent discussions among investment professionals, a notable shift in sentiment has been observed, particularly from the Schroders Unconstrained Fixed Income teamRecent economic indicators have taken a toll, igniting what they refer to as "animal spirits," thus increasing the likelihood of an economic scenario known as "no-landing." This term describes a situation in which the United States economy continues to expand without the expected cooling, leading to persistent inflation and limited interest rate cuts from the Federal ReserveTheir analysis has pushed the probability of such a scenario to 35%. Despite the investment market's recent adjustments to incorporate this no-landing situation, the increased probability continues to warrant caution regarding long-duration bonds.

The team's examination highlights that should the economy hard land, we would witness a drastic reduction in economic activity accompanied by a necessity for further rate cuts, although the probability of such an occurrence currently sits at a mere 5%. In the near term, there are few valid concerns about the threat to the U.S

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economic outlookWhile these scenarios have global implications, the present vitality of the U.Seconomy plays a significant role in shaping the perceived risks tied to various economic outcomes.

As the year 2025 approaches, there's escalating evidence suggesting that American enterprises are beginning to adopt a more positive outlook toward the new governmentThis translates to robust economic data that is expected to remain on an upward trajectoryInterestingly, small business confidence has seen considerable gains, and the manufacturing sector continues to experience expansionRecent reports indicate an increase in job vacancies, signaling that businesses harbor a stronger belief in the mid-term economic climate.

With economic growth remaining steady, optimism within the market regarding future prospects has also improved significantlyThere are signs that the U.Seconomic environment may become excessively strong

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For instance, the unemployment rate had shown a downward trend by December 2024. This factor is critical for the Federal Reserve as it leads to a slight upward revision of the unemployment rate forecast for 2025. Currently, there seems to be no pressing need for the Fed to react abruptly, especially given that wage pressures appear to be easing and inflation remains relatively in checkNevertheless, vigilance is warranted, as the elevated probability of the no-landing scenario introduces inherent risks.

Another compelling argument supporting the premise that the U.Seconomy could maintain its upward trajectory in the next few months revolves around the historical performance of economic data in the first quarter post-pandemicTypically, this period exhibits notable seasonal strengthThus, even though recent data suggests positive revisions, the overall forecast for U.Seconomic growth in 2025 may be subject to upward adjustments.

The yield curve could potentially steepen further, especially favoring U.S

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agency mortgage-backed securities (MBS). Despite the recent adjustment of market sentiment toward the no-landing scenario, Schroders retains a cautious stance on long-duration bonds due to the recent elevation of this scenario's probabilityPresently, maintaining a neutral approach seems most prudent, considering the growing momentum in U.Seconomic growth, the increase in job figures, and the limited advancements made concerning deflationNevertheless, Schroders holds strong convictions about the likelihood of a steeper yield curve in the upcoming months, particularly in the U.SmarketWhile short-term rates may continue to be influenced by federal fund rate expectations, if signs of an economic downturn become apparent, this could lead short-term rates to decline, presenting an attractive asymmetric opportunity.

On the longer end of the curve, the uptick in bond term premiums has exerted pressure on yield rates in recent weeks, yet there remains a belief that further development potential exists, especially given the historically low starting point

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The strategy selection for fixed income allocation becomes critical in this contextThe firm has not made substantial changes to its fixed income configuration this month, maintaining a steady and prudent investment approach while expressing strong preferences for U.Sagency MBSDespite the prevailing trend of rising sovereign bond yields and heightened market volatility, U.Sagency MBS stands out due to its appealing valuations, allowing it to sustain itself relatively well within the current market environment.

This asset class not only provides stable cash flow and a lower risk profile but also offers a good potential return horizon for investors, justifying its inclusion in a focused allocation strategyIn corporate credit sectors, the emphasis is placed on short-duration European investment-grade creditIn-depth market research and data analysis indicate that these assets appear relatively more attractive in the current market conditions

Compared to other corporate credit offerings, short-duration European investment-grade credit benefits from reduced credit risk and better liquidity, ensuring asset safety while contributing stable returns to the portfolioMore broadly, the stance on high-yield bonds remains cautiousGiven the prevailing valuation levels, these instruments lack sufficient allure to meet the firm’s requirements for investment yield and risk managementHowever, regional comparisons reveal that European high-yield bonds present marginally better value than their American counterpartsAlthough they still warrant cautious consideration, European high-yield offerings hold considerable relative investment merit.

Consistent with the investment strategy for December 2024, MBS continues to enjoy relative favor within Schroders' fixed income allocationCompared to investment-grade credit and SSA bonds, the valuation of MBS appears more appealing, capable of providing more stable and attractive returns to the investment portfolio