For macro and bond investors, 2024 has been challenging. Despite central banks cutting rates, bond yields have remained high, and country-specific macroeconomic factors have heavily influenced allocation strategies. Looking ahead to 2025, returns in global fixed income will largely depend on the trajectory of the U.S. economy and the extent of the Federal Reserve's easing measures. Macro nuances are expected to continue playing a critical role in cross country performance.

Participants:

• Jason Daw (Desk Strategy), Head of North America Rates Strategy
• Blake Gwinn (Desk Strategy), Head of US Rates Strategy
• Peter Schaffrik (Desk Strategy), Head of UK/European Rates & Economics
• Su-Lin Ong (Research), Chief Australia Economist
• Robert Thompson (Research), Australian Macro Rates Strategist

* Research Analyst opinions are their published views, independent of those expressed by Desk Analysts

Jason Daw:

While a good part of global fixed income returns are going to depend on how the US economy evolves and how much easing the Fed undertakes macro nuances will again be important in 2025 to assess the macro outlook, the evolution of central bank policy and what that means for the bond market. Today I'm joined by my global fixed income colleagues, aside from myself covering Canada, we have Blake Gwinn on the us, Peter Schaffrik on the UK and Europe and Su-Lin and Robert on Australia. Blake is going to kick off the discussion and enlighten us on one, why the US economy has been so resilient and if that can continue. Second, how many more cuts are in store For the Fed recall, the Blake's been at the extreme end of consensus expecting fewer cuts than the market or consensus, which has now moved in our direction. And third, what this all means for the bond market outlook. So over to you Blake.

Blake Gwinn:

You can see in surveys and many other qualitative sources like the Fed's base book that consumers and businesses were kind of holding off on large plans, whether that's spending investment CapEx waiting for some clarity on the US political situation for the next few years with the election passed, they can now start to plan out what the next few years is going to look like for regulation and taxes and we think that's going to unleash some pent up activity into the economy heading into early next year. Also on immigration, we've already seen immigration numbers starting to fall from their prior peak very quickly. That's before you really start layering on any potential implications for immigration policy on Trump's presidential victory that will lead to some upward pressure on inflation upside risk to inflation in the first half of next year. Also, residual seasonality we've seen over the past few years that we've had very hot inflation data in Q1, we would expect that that residual seasonality is going to show up again in 2025.

Inflation market I labor markets are cooling even if that is still towards normalization and not really risks of a hard landing. And so from that perspective I think they are fine continuing that cutting cycle. So again, cuts in December, January. Now by the time we get to the March meeting, I think from the fed's perspective, those tailwinds to inflation that we mentioned are going to start to pick up even if they aren't manifesting in higher inflation prints. I think they at least represent upside inflation risks for the Fed and through their kind of perspective of this balance of risks where they were seeing a lot of at least slightly more downside risk on the labor side of their mandate and very low upside risk to inflation late last year when they started the cutting cycle late this year when they started the cutting cycle. Looking into next year with those inflation risk rising and with labor markets continuing to stay stable, those downside risks to labor will start to come off.

I think steep iners have still been one of the more popular positions among market participants. I think a lot of this relies on this kind of historical perspective that says when the Fed is in a cutting cycle, curves should steepen, but with that abbreviated cycle, I think the steepening is also going to be very abbreviated and we see flatter curves in 2025. I think the front end is going to have to reconcile with this stronger economy, a higher terminal rate that we're expecting, but also the possibility that as I mentioned the next phase is actually hiking, that this really isn't just a delay of the hard landing but a delay that actually ends with another lake higher in the economy. Through all that, I think the long end remains relatively well pegged. We are not big believers in the term premium narrative deficits are going to remain high.

I will say that most of the impacts from the election are not only very uncertain as to how the platform of Trump will actually translate into policy action, but I would also say that a lot of that is backloaded. I think when we're thinking about our 2025 year ahead, there is some risk to both sides of our forecasts from the outcome of the election, but I think mostly what we're looking at is impacts that would come to pass in 2026, not 2025 near term. I think on the positive side, on the upside for inflation, upside for yields, it's possible that they push through tax cuts early. We will have that scheduled end of a lot of those Trump tax cuts at the end of 2025. We think they could preemptively try to roll those over. I would say that rolling those taxes over is probably baked into prices right now.

So what we're talking about here is really the possibility that they're much more aggressive on pushing not just a rollover of the Trump tax cuts but something a lower corporate rate, more cuts across the board than are expected. Also on the upside with regards to inflation pressures and yield pressures, further cuts in immigration, I think of all the potential outcomes of the election when we're thinking about our rate forecast, this one is not only perhaps the most impactful in the near term, but it's also one of the actions that's most likely because it doesn't rely on Congress to pass anything in the way that tax cuts do and even potentially some of the broad tariffs that Trump is talking about would have to go through congress. Immigration is something they can kind of do on day one and could have some very strong upward near term impact on inflation.

The last, I would say trade war uncertainty. This is something that is very hard to kind of wrap your mind around what we're actually going to get. Obviously Trump has talked about some very big broad sweeping tariffs on the campaign trail. What actually gets enacted is a lot less certain. Are these tariff talk going to be more a bark than bite or do we see those actually put into place? We don't know and I am not taking a strong view on that, but I think what remains true for the near term as far as our forecast is this is going to lead to some near term volatility. We are very, very likely to be getting a constant flow of headlines around it, whether that's tweets or statements from Trump about various trade policies. That is going to be something that keeps markets on edge for the near term.

Jason DAw:

The third headwind is changes in immigration policy and that could shave a decent amount of growth over the next two years. The new government targets are quite aggressive, difficult to see them being fully implemented or materializing, but regardless, immigration will shift from being a positive to a negative impact on growth. Then on the inflation front, based on the current and future growth conditions, there is a higher possibility in our opinion that inflation dips below 1% in 2025 instead of it being above 2%. We've had excess supply in the product market, excess supply in the labor market and when you couple that with dynamics and mortgage interest costs, there should be a strong downward bias to inflation over the next year. For monetary policy, our opinion is that the Bank of Canada is more behind the curve than ever before in an easing cycle. Usually they're cutting well before the economy gets into excess supply, but this cycle they've been very late, which was necessary to squeeze inflation out of the system and to put it in context, if we were in a low and stable inflation cycle last year, the Bank of Canada would've probably already started cutting rates last summer and maybe already completed the easing cycle by now.

The exceptions are small cutting cycles such as 1998 and 2015 or a situation like 2020 when rates were cut from already low levels and inflation was high and volatile. Now when you look at the fundamental factors, they are supportive of duration, specifically two main drivers of bond yields, policy rate expectations and pricing and macro growth and inflation. Those are slanted towards a favorable environment for bonds with a high margin of safety. In our opinion, the next 50 basis point move in 10 year bond yields we think is decidedly skewed to the now. From a cross market perspective, the divergence in Bank of Canada and fed policy that can possibly reach post inflation targeting limits. I think it's important to remember that the only episodes over the past 30 years where policy cycles were very aligned between Canada and the US was during common shock episodes such as the 2001 tech bubble, the commodity boom leading up to G-F-C-G-F-C and into and out of covid.

No matter what, Canada cannot escape the gravity of US treasuries, but divergence in relative macro fundamentals has and can continue to support a notable drift. For example, this year Canada US spreads, they move deep into negative territory and 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. As far as the curve, it should steepen but not as much as past cycles Consistent with history, every segment of the yield curve has been on a steepening trajectory since the Bank of Canada embarked on its easing cycle. Our forecast and vision further steepening from here with the degree dependent on how much the Bank of Canada cuts relative to market pricing. If our 2% terminal rate is achieved on a carry adjusted basis, five thirties, tens thirties, they probably offer the most compelling opportunities relative to other parts of the curve such as twos, tens.

And lastly, I want to highlight two political risks to our outlook on the Canadian side. According to the polls, it's a matter of when not if there'll be a change in federal leadership. Right now the conservatives are set for one of the largest mandates in history, whether there'll be marginal or larger scale policy changes, that's difficult to predict, but in general there could be some consistent chipping away at the policies over the past 10 years that the liberals and NDPs put in place. The clearest changes would be probably less tax and less spending. Other areas where changes could be afoot are on climate, carbon tax, energy regulation, pipelines, immigration, foreign competition, possibly growth and inflation impacts are definitely murky, but there is the potential for more business friendly policies that could help mitigate some of the severe underperformance in Canada. Business investment and productivity on an absolute and relative basis to the us now the conservatives do appear more inclined to pursue a balanced budget, but the timing of achieving it would be uncertain with our budget deficit at only 1.5% of GDP, the impact on issuance would be minimal over a multi-year horizon.

Peter Schaffrik:

Therefore the question is will the economy slow down even further or more likely will it stabilize around current levels as the ECB cut rates? And we are returning to an environment where wage growth remains relatively ample and we're talking again about domestic inflation pressures which we think is more likely add on top of that potential changes through tariffs or other policies that on balance are probably going to be negative for Europe but are also probably going to be inflationary and the problem could be exacerbated. What does that mean for the ECB? We have forecast 25 basis point rate cuts consecutively until April and the terminal rate therefore at two and a quarter percentage points that is higher, although not significantly higher than what the market is currently implying and we feel quite comfortable with that. It remains to be seen whether any significant policy changes particularly on the tariff front is going to be so negative that the ECB would have to cut much deeper and indeed if the labor market loosens, but our base assumption is that neither of those is going to happen and therefore we can see the ECB plateauing round about the middle of the range that they consider neutral at about two and a quarter as I suggested earlier and then adopting a wait and see approach.

What also needs to be considered is that we get domestic changes from the political front here in Europe as well, particularly with the German elections coming up and one of the elements that should be considered is that just as Jason was outlining in any potential changes in political leadership in Canada, one of the other elements that should be considered is it is likely going to be political leadership changes afoot here in Europe as well, most notably in Germany where elections are going to be held now in February and we'll probably get a shift to the center right and with that are probably going to be some policy changes, particularly as far as energy policy is concerned, migration policy is concerned and probably fiscal policy as well that could if anything change the outlook slightly to the better, which again would be exacerbating the potential domestic pressures that I've outlined already.

What does it mean for the bond market? It seems difficult even at these mediocre outlooks for the economy to get bullish bonds, particularly the longer end of the curve is also pressured by ongoing QT pressures from the ECB and we've already seen a significant underperformance of government bonds relative to swaps in particular that have put upward pressure on bond yields as well. We don't see a significant selloff, but we don't see a bond bullish environment unfolding in Europe. What about the uk? Now the situation for the UK is very similar but as one key caveat or at least one key caveat, we recently had a budget in the UK that has expanded the fiscal stance quite substantially. That was the first budget of the new labor government and it has certainly surprised to the looser end. The Bank of England has taken account of that yes, they have cut rates, but they have acknowledged that a looser fiscal stance probably means a stronger economy and a more gradual return to the inflation target.

It seems likely that the market's reduction in implied rate cuts from the Bank of England is relatively accurate, particularly if the economy at the end of the day continues to chuck along at a relatively tight labor market. Very similar to the situation that I've just outlined for your area and domestic inflation pressures do not recede as quickly as we're previously expecting. What does that mean for the UK bond market? We've already seen a significant repricing from the front end and the backend of the curve is already hovering somewhere between where the Euro area has been seen and where the US is going. At the end of the day, the UK is even more at the mercy of where treasuries are going than the Euro area because the Bank of England's leeway to cut rates is probably even smaller than that. For the ECP, we think there's probably going to be some steepening of the curve and the risk in the UK of a increased term premium is probably higher than another markets because markets are already on tender hooks when it comes to the UK's fiscal outlook as a summary.

Therefore, the outlook for Europe is certainly not great and the implications from the Trump election have downward pressures for sure. The question however is whether that translates into significant rate cuts and we have our doubts with low productivity growth and domestic tight labor markets. That means inflationary pressures remain there and with a potential loosening of fiscal policy or an actual fiscal loosening in case of the uk, that pressure is if anything only going to be bigger. We find it difficult to be bullish on European bond markets and think that the risk for yields is slightly to the upside. The risk for the curve is for slight steepening and certainly the risk for asset swaps is probably still on the underperformance for government bonds relative to swaps.

Jason Daw:

Su-Lin Ong:

So the first one of these is around household consumption, which we do expect to lift in 2025 to around 2% that would still be below the long run trend and soft, but the across the board income tax cuts effective from one July this year coupled with lower headline inflation is helping to lift real incomes. There is obviously a lot of debate over whether households will spend this additional income or save and pay down debt, but we think there's scope to do both in the year ahead. At the aggregate level, households barely saving with the household savings rate at just 0.6% and that's well below the long run 5% average. Our expected pickup in activity overall is largely dependent on a firmer consumer amidst what is likely to still be a reasonably healthy labor market in 25, some real wage growth and some hopefully modest easing from the reserve bank.

Secondly, we expect public demand, especially government consumption to remain strong. It's been a key contributor to activity keeping GDP positive for much of the last couple of years. Around 80% of this public demand is government consumption and it's concentrated in areas like health and social assistance, education and defense. Australia has a particularly large government program called the National Disability Insurance Scheme, the NDIS, and that has been quite a key contributor to government expenditure. Public demand continues to rise as a percentage of GDP and at just over 28%. It's at record levels outside of the covid period. We a federal election due by May of next year and the government is consistently behind in the polls. It is likely then the fiscal policy earns more expansionary in 25. There are clearly parallels to the recent US election. Cost of living remains a key issue amongst voters and we do expect further measures to be announced in the coming months, either at the midyear update in December or possibly an early federal budget in March of next year.

Thirdly, there are some encouraging signs in residential construction. Most of the leading indicators have stabilized or be it at decade low plus type levels and are starting to turn upwards. There are obviously a whole lot of challenges for housing construction. We still have pretty elevated material costs, shortages of labor, long approval times and some fairly costly inbuilt taxes, but the data suggests that it should start to stop dragging on activity further into 25 with some uplift likely and that will be very welcomed given the continued shortfall in supply. 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 next year. It's obviously early days and there's clearly a lot of uncertainty around exactly what policies will be enacted and the timeframe, but the imposition 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 marker and trading partner, weaker Chinese growth as well as weaker global growth plus more inwardly focused economies and reduced global trade bodes poorly for an open economy like Australia.

The lagged impact of weaker activity should see some softening in the labor market in 25, but we note that the starting point is stronger than we thought across multiple metrics that we've spoken a lot about on macro minutes throughout this year. In particular, we've been surprised by the persistent outsize gains of monthly employment generation with the strength of government spending in health and the NDIS, which is spilling over to a lot of health and social assistance jobs, they now account for around 15% of total employment and rising. The unemployment rate has lifted from a 50 year low, but at a little above 4%. The labor market remains tight and a global outperformer especially versus its dollar block cousins like Canada and New Zealand. The leading indicators of employment do suggest some moderation in the labor market next year, but with most of the vacancy data staying above pre covid levels and ongoing public demand, we look for only a modest lift in the unemployment rate to a four and a quarter to four and a half percent range for much of next year, not far from full employment and still low by historic standards.

Some listening in the labor market, including ours worked and the pace of job creation should see a cyclical lift in productivity helping bring underlying inflation just back within the RBAs two to 3% target by the second half of 25 at 3.5%. It has moderated, but it's still a little high and key components, especially services inflation is still pretty sticky and it's moving sideways around 4.5%. This is key obviously for the RBA, which unlike the rest of the dollar block in Europe, has remained patiently on the sidelines with the cash rate unchanged at 4 35 since November of 23. Having not taken the policy rate as restrictive as most other countries, the hurdle to cut has always been higher and the easing we expect in 25 will also likely to be much smaller by global standards. Our base cases for a modest 75 point easing cycle beginning in February, but the risk is for a later start in May and possibly just 50 basis points of adjustment cuts, especially if there's uncertainty around US policy after a new administration begins in late January, as well as uncertainty around new Australian election related type expenditure. Labor market dynamics will be important and we think the onus is on the suite of labor market data in the coming months to weaken if the RBA is to join that global easing cycle in February of next year. Rob, I'm going to turn over to you for some thoughts in terms of the market outlook for 25.

Robert Thompson:

Jason Daw:

Speaker 6:

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