SECOND QUARTER 2025

The Big Picture

Western Asset's latest insights on economic drivers and credit markets for fixed-income investors.

"We continue to expect a strong year for fixed-income markets, driven by attractive yields and opportunities in select spread sectors. The unpredictability of US administration policy initiatives may continue to spark episodes of market volatility but should also provide opportunities to augment existing positions. We remain diligent about fundamental credit research and have taken measures to move up in quality in the near term."

Michael Buchanan, CFA
Chief Investment Officer
2Q25 HIGHLIGHTS
  • We remain optimistic about the potential for fixed-income returns in 2025.
  • In the US, while tariffs will dampen growth, we do not anticipate a recession given the prospect of lower oil prices, tax cut extensions and a lenient regulatory environment.
  • The US disinflationary trend may be interrupted as tariffs are implemented, but we expect inflation to gradually moderate.
  • In Europe, we expect the ECB to continue rate cuts as inflation wanes. German infrastructure spending and increased EU defense spending is beneficial for confidence and future growth despite near-term headwinds.
  • China may face slowing economic growth due to US tariffs. The country will likely deliver a larger stimulus package to boost domestic demand and reduce consumption bottlenecks.

Proposed tariffs from the new US administration have created volatility in financial markets. Global growth is expected to slow given heightened unpredictability but should remain positive. US growth is downshifting due to a myriad of factors including tariff uncertainty, waning benefits from immigration and reduced government spending. A significant fiscal boost from European defense and German infrastructure spending should support eurozone growth and provide relief from tariff-related uncertainty. Deflationary pressures in China persist and confidence is weak amid property market concerns, but sentiment is improving with fiscal stimulus and policy easing. Monetary policy remains restrictive, and we believe that central banks will continue to cut rates in 2025. The Federal Reserve (Fed) remains well positioned to provide support if the US economy falters. Public debt levels continue to rise and yield curves may steepen given concerns over fiscal policies. While we retain a modest overweight to interest rate duration, we are concentrated in shorter maturities. Sector spreads have widened and valuations are now closer to fair value in our base-case scenario.

"Tariffs and central banks are engaged in a delicate balancing act in 2025. While proposed US tariffs have injected uncertainty into global markets and may temporarily interrupt disinflationary trends, central banks remain positioned to provide support through rate cuts. The Fed stands ready to counterbalance economic faltering, while other central banks are expected to ease policy. This monetary flexibility provides a crucial stabilizing mechanism as markets navigate trade policies."

Mark S. Lindbloom
Deputy CIO & Head of Broad Market Portfolios

KEY DRIVERS AND RELATIVE VALUE BY REGION


US: Soft Landing Remains on Track


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This year's growth and inflation trade-off is highly dependent on Trump's policies. Despite market uncertainty, the US economy should just manage to retain positive growth in 2025. Core inflation measures already show moderating services inflation, while the impact from tariffs should be a one-year event only. Barring a recession, we expect US Treasury (UST) yields to trade in a range of 4% to 5%.


EUROPE: Lacklustre Growth with Inflation at Target


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We expect the European Central Bank (ECB) to deliver further cuts this year. Headline inflation is trending close to target, and service inflation is beginning to soften in line with our expectations. The large German infrastructure fund and increased EU defense spending should boost both growth and confidence. We maintain a modest overweight duration position through both nominal and real yields.


UK: Further Removing of Policy Restraint Remains Appropriate


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Growth has been limited since mid-2024 and is likely to remain subdued. Headline consumer price inflation has risen, but should return to the Bank of England's (BoE) 2% target over its forecast horizon. We expect further labour market weakening to add downward pressure to wage growth, providing confidence for the BoE to cut rates beyond what the market is currently discounting. UK gilts should provide positive returns.


"CMBS offers compelling opportunities with improving commercial real estate fundamentals and attractive spreads. Constrained underwriting has created high-quality, low-leverage investments with income and total return potential. Property prices are growing from cyclical lows with healthy fundamentals. We remain cautious about tariff impacts that could cause demand destruction across CRE sectors."

Simon Miller
Portfolio Manager

SECTOR THEMES

Investment-Grade (IG) Corporate Credit


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IG corporate fundamentals have been resilient. Management commentary and outlooks have been more cautious given policy uncertainty. We have started to see sector dispersion amid recent volatility: banks, noncyclical industrials and utilities are outperforming while autos, energy and lower-quality rating cohorts underperforming. Technicals remain supported by steady demand from institutional buyers. We see opportunities in global banks as a potentially advantageous risk/reward mixture to play offense in a defensive way.

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European credit fundamentals remain sound, especially in banking. Utility sector ratings in Europe have stabilised with headroom for balance sheet expansion to fund energy transition investment. Some sectors such as autos are facing cyclical and structural headwinds and tariff-related uncertainty. We remain overweight financials, utilities and select property companies.

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In Australia, fundamentals remain sound due to defensive issuer selection. The high concentration in monopolistic and duopolistic businesses (as well as in regulated utilities and infrastructure) naturally provides predictable cash flows and profitability. We maintain concentrated shorter-dated credit holdings but are opportunistic amid high volatility. We retain a preference for new issuers with premiums, select REITs and utility/infrastructure assets.

High-Yield (HY) Corporate Credit


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In the US, HY credit spreads reflect balance sheet strength, the prudent behavior of management teams and supportive demand for higher-yielding securities relative to supply. We continue to see selective opportunities in service-related sectors that are still recovering from pandemic-era recession, energy (E&P) and potential rising stars. We are more cautious about consumer products, retailers and home construction sectors.

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In Europe, corporate fundamentals continue to be positive. Net supply remains low as most bond issuance is aimed at refinancing. We continue to focus on BB/B rated issues with a bias toward telecom/cable, consumer and select capital good companies.

Bank Loans


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As growth expectations moderate, we prefer the core of our bank loan exposure in BB rated loans with strong underlying balance sheets, and a selective allocation to B rated loans within defensive sectors to take advantage of outsized carry relative to other fixed-income products. We expect cyclical sectors to be volatile with specific concerns around the automotive, chemicals, building materials and telecom industries.

"We maintain a positive outlook for key sectors. Global banks benefit from resilient performance and low risk profiles. Energy midstream shows strength through strong balance sheets. Gaming fundamentals remain sound with promising growth in Asia. Telecom offers defensive characteristics with recurring revenue and strong cash flow. These sectors can provide a measure of stability amid volatility."

Michael T. Borowske
Head of Global Credit Research

INDUSTRY THEMES

Industry
Key Observations

Auto & Related

We favor market weight positioning in both IG and HY, as the risk/reward balance skews more negatively than in the last 12-24 months. Tariff uncertainties have resulted in significant spread widening across both US and European OEM and Tier I suppliers. We see very few rising-star candidates and anticipate rating agency downgrades this year.

Banks

We maintain a large overweight position to top-quality global banks given resilient performance, as banks have lower risk profiles due to stringent regulations, heightened oversight and improved risk management following the global financial crisis.

Energy

We favor market weight positioning with an overweight bias to the mid-stream/pipelines subsector. Continued themes of low growth/capital discipline, balance sheet strength and consolidation remain generally positive. Oil prices have reacted negatively to tariffs, increasing downside risks. Natural gas fundamentals remain strong.

CONTINUE READING

Macro Market Trends:

Global Public Debt Burdens

In his latest market commentary, Western Asset CIO Michael Buchanan examines the impact of rising public debt and market concerns over government fiscal policies. Elevated debt levels and fiscal policies have increased bond market volatility. Michael discusses the implications of global debt burdens by region with Western Asset's key macro decision-makers.

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