Securing the Soft Landing

Key Takeaways

In the wake of pandemic shocks, economies appear more “normal” than at any time since 2019. Yet policy rates remain elevated. As central banks cut interest rates to more neutral levels, key questions include how fast they get there and what those neutral levels will look like. Here are our near-term economic views:

  • The factors that supported relative U.S. economic strength are diminishing. That suggests some recoupling with the rest of the world and further progress on curbing inflation.
  • Developed markets (DM) appear on track to return to target inflation levels in 2025, driven by normalizing consumer demand and increased competition for limited job openings. In the U.S., labor markets appear looser than in 2019, heightening the risk of rising unemployment. The Fed, like other DM central banks, is expected to realign monetary policy to this new cyclical reality.
  • The U.S. economy, like others, appears poised to achieve a rare soft landing – moderating growth and inflation without recession. But there are risks, such as the upcoming U.S. election and its implications for tariffs, trade, fiscal policy, inflation, and economic growth. High budget deficits will likely persist, limiting the potential for further fiscal stimulus and adding to economic risks.

As developed economies slow and potential trade and geopolitical conflicts loom, investors should favor caution and flexibility in portfolio positioning. These are our near-term investment views:

  • We expect yield curves to steepen as central banks lower short-term rates, creating a favorable environment for fixed income investments. Historically, high quality bonds tend to perform well during soft landings and even better in recessions. Moreover, bonds have recently resumed their traditional inverse relationship with equities, providing valuable diversification benefits.
  • Bond yields are attractive in both nominal and inflation-adjusted terms, with the five-year area of the yield curve particularly appealing. Cash rates are set to decline alongside policy rates, while high government deficits may drive long-term bond yields higher over time.
  • We maintain a cautious stance given some complacency we see in corporate credit due to tighter valuations, favoring higher-quality credit and structured products. Lower-quality, floating-rate private market areas appear more vulnerable to economic downturns and interest rate changes than prices suggest, with credit risks poised to rise just as yields fall, potentially benefiting borrowers but hurting investors. U.S. agency mortgage-backed securities (MBS) offer an attractive and liquid alternative to corporate credit.1 Additionally, asset-based sectors, in both consumer and non-consumer areas, provide appealing opportunities for private market investors, particularly relative to corporate lending.
  • In foreign exchange, we are somewhat underweight the U.S. dollar as the Fed cuts rates, while diversifying into currencies from both DM and emerging markets (EM).

Economic outlook: Recoupling and a reframing of risks

The U.S. economy distinguished itself in 2023 and 2024, achieving growth rates of 2.5%–3%, while DM peers largely stagnated at 0%–1%. U.S. productivity has also outpaced DM peers since the pandemic. In our April 2024 Cyclical Outlook, “Diverging Markets, Diversified Portfolios,” we identified two main drivers:

  • Fiscal policy: A larger cumulative fiscal stimulus since 2021 has led to greater private wealth accumulation in the U.S., which has taken longer to dissipate.
  • Monetary policy: The pass-through of higher interest rates to households has been slower in the U.S., largely due to the existing stock of low-rate, long-term mortgages.