Summary

1. Fed holds, ECB moves: The Fed is likely to remain patient on rate cuts, while the ECB may act faster due to economic headwinds. We still expect two rate cuts this year for both the Fed and the ECB, with cuts in June and December in the US, and in April and June in the eurozone.
2. Seeking safe-haven: Trump’s new tariffs have heightened uncertainty, raising the risk of a trade war or prolonged negotiations. Investors are likely to seek safe-haven assets, keeping US yields under pressure. In response, we have turned tactically Positive on US Treasuries, revising our 3-month US 10-year yield target to 4%. We also maintain a Positive stance on core eurozone government bonds, with a 12-month German 10-year yield target of 2.50%.
3. Topic in focus: Keep calm and buy gilts: UK gilts have been acting as a safe-haven since the US announcement of massive tariffs. We believe gilts can continue to outperform, supported by cooling inflation, fiscal restraint, expected policy rate cuts and a favourable shift in gilt issuance. We anticipate strong returns over a 12-month horizon and little change in the currency against the euro or dollar.
4. Opportunities in Fixed Income: In addition to US, core eurozone and UK government bonds, we are Positive on US Agency Mortgage-Backed Securities, US TIPS, and eurozone and UK investment grade corporate bonds.

Central Banks

Fed holds, ECB moves

European Central Bank (ECB)

Market recalibration: Traders priced in fewer rate cuts after Germany's fiscal stimulus, but then priced in more cuts as a result of Trump's tariffs and higher recession risk. They now expect 2.6 rate cuts of 25bp this year and a terminal rate of 1.8%.

Policy stance: The disinflation process remains on track. Monetary policy is becoming much less restrictive, suggesting only a few more cuts in the future.

Our expectations: We still expect two rate cuts this year, but the higher downside risk to growth from Trump’s massive tariffs may prompt the ECB to act sooner rather than later, i.e. in April and June rather than June and September.  In our view, the German fiscal plan should prevent the ECB from cutting rates too aggressively as it raises the medium-term outlook for economic growth and inflation. The ECB could consider raising rates in the second half of 2026 as the economic effects start to feed through.

US Federal Reserve (Fed)

No rush to cut rates: The March FOMC meeting made a subtle shift towards accommodative liquidity conditions by slowing quantitative tightening, with the result that the Fed will become a net buyer of Treasuries from April. On the interest rate side, there is no urgency to cut rates despite tariff risks. Hard data has not weakened, contrary to surveys, leading the committee to overlook these less reliable signals.

Policy outlook: All members expect higher inflation this year only, with forecasts for 2026-27 unchanged, supporting Powell's view that tariff inflation could be transitory.

Our expectations: The Fed is likely to remain on hold for now, given recession concerns and the risk of long-term inflation expectations drifting above 2%. We expect the Fed to cut rates twice this year (in June and December) in response to the expected deterioration in economic growth and the labour market, and to end the cycle with a policy rate of 4%. 

Bond Yields 

The great slide

We changed our stance on US Treasuries from Positive to Neutral last month, as we believed that bond yields had already fallen significantly. However, Trump's decision in early April to impose sweeping new tariffs on several US trading partners has introduced a new layer of uncertainty, potentially setting the stage for a prolonged trade war or protracted negotiations. Against this backdrop, we expect market uncertainty to persist in the near term, prompting investors to seek refuge in safe-haven assets. This dynamic should continue to put downward pressure on US yields. In response, we have turned tactically Positive on US Treasuries and revised our 3-month target for the US 10-year yield to 4%, while maintaining our 12-month target at 4.25%.

We expect a similar flight-to-quality effect in Europe, benefiting German bunds and other core eurozone government bonds. We are therefore maintaining our Positive stance on core euro government bonds, with a 12-month target for the German 10-year yield of 2.50%.

Topic in Focus

Keep calm and buy gilts

Gilt issuance strategy shifts: The UK Debt Management Office (DMO) has made a significant adjustment in its bond issuance strategy for the 2025/26 fiscal year. It plans to reduce the issuance of long-dated conventional gilts from 19.9% to 13.4%, while increasing the issuance of short-dated gilts from 35.9% to 37.1%. This shift reflects the government’s strategy to adapt to higher borrowing costs and maintain flexibility in a volatile market. The decision was well-received, with long-term gilt yields declining in response.

Fiscal policy uncertainty: While the UK government avoided immediate fiscal tightening in its Spring Statement, the optimistic economic forecasts from the Office for Budget Responsibility (OBR) raise concerns (see chart). Growth expectations seem excessive, and the proposed consolidation measures -mainly welfare reforms and departmental spending cuts- may face political resistance. With further adjustments likely in the Autumn Budget, uncertainty over public finances remains high, creating a complex backdrop for gilts.

Bank of England’s expected moves: We anticipate that the Bank of England will cut interest rates by 75 basis points this year and by a further 25 basis points early next year, leading to an end-of-cycle rate of 3.50% in 12 months’ time. This is significantly more than the 70 basis points currently priced in over the next 12 months. Given that monetary policy is a key driver of gilt yields, these rate cuts should provide support for bonds.

Strong return potential: UK government bonds offer an average yield of 4.5% (see chart) with a duration of 8.4 years. We expect bond yields to decline – for example, we think that the 10-year yield will drop from the current 4.4% to 4.0% in 12 months. This drop in bond yields would translate to an expected total return of close to 7% over one year for UK government bonds, making gilts an appealing choice for global investors (we do not anticipate major changes in EUR/GBP or USD/GBP over the next 12 months).