Unconstrained fixed income views: September 2025

We explore why the rather vague concept of a ‘neutral policy rate’ is becoming more important to central banks – and why it is important for the outlook for bonds.

For a central bank, assessing what is the ‘neutral’ interest rate is an important – but theoretical – part of its monetary policy framework. Conceptually, it’s the balance point, where interest rates are neither ‘restricting’ nor ‘stimulating’ economic activity and can be influenced by a variety of factors, such as productivity growth or demographics.

Because it’s so hard to know what the ‘neutral’ rate is, what matters more for bond markets is how close central banks ‘think’ they are to neutrality. This is because if a central bank feels it has reached neutral, it will likely react to new data differently to one that believes itself to be in restrictive territory.

So what does this mean for bond markets? Well, the European Central Bank (ECB) already believes that it is now at a neutral policy rate setting, having halved interest rates since the start of the current cycle in mid-2024.

The market is fully pricing the US Federal Reserve (Fed) to move to neutral over coming quarters too. Similarly, for duration (interest rate risk) we also move our score to ‘neutral’. The prices of these bond markets are already reflecting our view, so it makes sense to be patient.

Have our views on the economy changed since last month?

As we move towards the final quarter of 2025, we continue to see a soft landing as the most likely outcome, with a 60% probability.  But the risks around that remain are skewed to the downside – a 30% chance of a hard-landing, and a 10% chance of a no-landing.

For the economy a soft landing remains our base case – but risks around this are skewed to the downside

Source: Schroders Global Unconstrained Fixed Income team, September 2025. For illustrative purposes only. % probabilities assigned to each scenario. We define a hard landing as one in which the Fed has moved rates by the end of 2026 into stimulative (e.g. below 3%) territory and a no landing as one where they have kept rates restrictive – we define it as above 4%. A soft-landing is one in which the Fed moves policy to within this band. “Soft landing” refers to a scenario where economic growth slows and inflation pressures ease, allowing modest further rate cuts; “hard landing” refers to a sharp fall in economic activity and deeper rate cuts are deemed necessary; “no landing” refers to a scenario in which inflation remains sticky and interest rates may be required to be kept higher for longer.

Past performance is not indicative of future results

Importantly though, we need to assimilate this economic outlook with what is priced into bond markets to assess the risk versus reward of our portfolio positions.

With US Treasury yields having already fallen (yields move inversely to price), we believe that about 50% of our estimation of hard landing is already in the price of bond markets. That’s why, when it comes to our overall view on interest rate (or duration), we don’t oppose rates market pricing at this stage, but neither do we seek to chase it. We wait patiently for better opportunities to arise.

Labour market slowdown, or labour market recession?

The US labour market has been in stasis over recent months. For cyclical assets, such as credit and equities, a slowdown in the labour market accompanied by easier monetary policy has so far been unproblematic, but a further, deep downturn in the labour market would be a problem.

So do we see a labour market recession from here as likely? In short, no. Our view is that the recent stall-speed reflects high uncertainty and companies have rationally held off both hiring and firing. As uncertainty eases, we expect stabilisation, but not a sharp rebound.

Why cut further? ECB back at neutral and happy there

We wrote last month that we felt the need for the ECB to ease rates further was limited and that they were moving towards agreeing with that assessment. Since then, our views on the matter are little changed and President Lagarde’s recent press conference suggested the governing council’s view continues to move in our direction.

We believe there remains room for eurozone yields to move modestly higher as the further cuts priced in for the ECB are removed, but also for curves to steepen (i.e. longer dated bond yields move comparatively higher to shorter maturities) due to worsening supply-and-demand dynamics for long-end bonds.

Waiting for better opportunities

We’ve mentioned our neutral view on interest rate risk, but how about our asset allocation views?

We continue to be wary of corporate credit in both investment grade (IG) and high yield (HY). While fundamentals like corporate profitability remain solid, valuations do not. Any weakening of the market would be an opportunity to add, but for now we are happy to wait patiently on the sidelines.

Instead, we continue to see better value in areas such as agency mortgage-backed securities (MBS), covered bonds (which are highly rates-securitised assets) and emerging market debt (both local currency and denominated in euros).

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Originally Posted – Unconstrained fixed income views: September 2025

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.