In 2025, Fixed income returns across the world will depend partly on the continuing resilience of the U.S. economy, and how far the Federal Reserve takes its current easing cycle. But macroeconomic variations among different markets will also be a big influence. In this episode of the Strategic Alternatives podcast, RBC Capital Market specialists from major global markets sift the key factors to offer informed predictions.
What is the global macro picture as we enter 2025?
Jason Daw: 2024 has been a frustrating year for macro and bond investors. Central banks have cut rates, but bond yields have not declined. However, macro nuances have mattered for country allocations.
The weak state of Canada’s economy, for example, has seen bonds outperform treasuries, whereas in Europe they have matched U.S. Treasury performance.
On the other end of the spectrum, Australia’s macro resiliency led to Aussie bonds underperforming, and similar in the U.K., compounded by supply concerns.
While a good part of global fixed income returns are going to depend on how the U.S. economy evolves and how much easing the Fed undertakes, macro nuances will again be important in 2025.
Can the resilience of the U.S. economy be sustained?
Blake Gwinn: The U.S. economy is on a very healthy footing heading into 2025. The consumer and business balance sheets are in very good shape; corporate profitability is high; consumption and growth remain very strong.
Labor markets are slowing, but we’re still not seeing any real permanent job losses. Very importantly, retirements are starting to rise, which leads to a lot of spending down of retirement assets – healthy for consumption, but also replacement demand for labor.
In early 2025, we see some additional tailwinds, particularly for inflation. One is simply pent-up demand following the U.S. election. We’ve already seen immigration numbers starting to fall — that will lead to some upward pressure on inflation.
What is the trajectory for U.S. interest rates and the yield curve?
Blake Gwinn: We do think the Fed will continue to cut a couple more times, even though we are in a very strong place. By late Q1/Q2 inflation tailwinds are going to start to pick up, even if they aren’t yet manifesting in higher inflation prints.
We think it’s going to be very easy for the Fed by then, after 100-plus basis points of cuts, to take a pause. We think that pause basically extends and rates remain on hold for the remainder of 2025, and perhaps even leave 2025 with a hiking bias rather than a cutting bias.
In other words, we think the economy is in the process of stabilizing, not the early stages of deterioration. Moreover, we think a 2025 pause could be the prelude to renewed expansion, rather than simply delay of an inevitable hard-landing.
Historical perspective says when the Fed is in a cutting cycle, curves should steepen. But with that abbreviated cycle and how much was already priced coming into it, I think the steepening is also going to be very abbreviated. We expect to see flatter curves in 2025.
“We think it’s going to be very easy, after 100-plus basis points of cuts, for the Fed to take a pause in H1 2025”
Blake Gwinn, Head of U.S. Rates Strategy
How does Canada compare in terms of inflation and monetary policy?
Jason Daw: The Canadian economy has struggled the past two years, and when you look at 2025, there is a trifecta of headwinds that suggests below-trend growth should persist.
The first is mortgage resets; the second is the U.S. growth trajectory; the third is changes in immigration policy. There is a higher possibility, in our opinion, that inflation dips below 1% in 2025, instead of being above 2%.
Disinflation risks won’t dissipate until excess supply is absorbed, which requires a period of sustained above-trend growth. For that to occur, we think policy needs to move into accommodative territory. Our current forecast is for the Bank of Canada to lower the overnight rate to 2% by the middle of 2025.
There are also political risks to our outlook in Canada. According to the polls, it’s a matter of when, not if, there’ll be a change in federal leadership. The clearest changes would probably be less tax and less spending.
On the U.S. side, Trump is threatening tariffs. Canada has a lot to lose, but so does the U.S. So we assign a very low chance that across-the-board tariffs would be put on Canada.
“We assign a very low chance that across-the-board tariffs would be put on Canada. Canada has a lot to lose, but so does the U.S.”
Jason Daw, Head of North America Rates Strategy
What’s the outlook for Canadian fixed income?
Jason Daw: We think 2025 should be a self-reinforcing cycle between macro and policy that leads to lower bond yields, marginally steeper curves, and GoCs outperforming treasuries.
History is on the side of owning fixed income. In most easing cycles back to the early 1990s, Canadian fixed income total returns have been between 5% to 15%.
On cross-country bond market performance, Canada-U.S. spreads moved deep into negative territory this year. We expect this trend of Government of Canada bonds outperforming to continue in 2025, as macro forces remain more conducive for large-scale cuts in Canada.
What’s in store for macro policy and bond markets in the U.K. and Europe?
Peter Schaffrik:The outlook for Europe is certainly not great, and the implications of the Trump election have downward pressures. The question is whether that translates into significant rate cuts, and we have our doubts. We have forecast 25 basis point rate cuts consecutively until April from the ECB, and the terminal rate therefore at 2.25 percentage points. We find it difficult to be bullish on European bond markets, and think the risk for yields is slightly to the upside.
In the UK we recently had a Budget that has expanded the fiscal stance quite substantially. The Bank of England has cut rates, but has acknowledged that a looser fiscal stance probably means a stronger economy and a more gradual return to the inflation target.
In the U.K. bond market, we’ve already seen a significant repricing from the front end, and the back end of the curve is already hovering somewhere between where the Euro area has been, and where the U.S. is going.
“We find it difficult to be bullish on European bond markets, and think the risk for yields is slightly to the upside.”
Peter Schaffrik, Head of U.K. and European Rates and Economics
Australia has resisted the rate cutting cycle so far – will that change in 2025?
Su-Lin Ong: The Australian economy is running at a pretty sluggish pace. Our expected pick-up in activity overall is largely dependent on a firmer consumer market, amidst what is likely to still be a reasonably healthy labor market in ’25, some real wage growth and some easing from the reserve bank. Our base case is for just 50bp of easing beginning in May.
We expect public demand, especially government consumption, to remain strong. There are also some encouraging signs in residential construction.
The risks to our modest but firmer growth outlook for ’25 are balanced, but we are mindful of the potential challenges to Australia from a Trump administration. The imposition of across-the-board tariffs of 10 to 20%, with 60% on China, and the risk of retaliation, is front of mind for us. As our largest export market and trading partner, weaker growth for China bodes poorly for Australia.
“As our largest export market and trading partner, weaker growth for China bodes poorly for Australia.”
Su-Lin Ong, Chief Australia Economist
Robert Thompson: Turning to fixed income markets, while the Trump victory might keep some marginal upside pressure on yields and curve shapes, much of this appears to have already been priced in. And Australia’s followed the move to slightly lower yields and flatter curves since the U.S. election.
“While the Trump victory might keep some marginal upside pressure on yields and curve shapes, much of this appears to have already been priced in.”
Robert Thompson, Australian Rates Strategist
