By: William A Goldthwait, Portfolio Strategist
The Fed’s glide path to neutral is intact, but late-cycle labor wobbles and sticky inflation keep us cautious: long duration, dry powder, and no heroics
Our base case for a soft landing remains intact, and market movements seem to agree. We see a total of three US Federal Reserve (Fed) rate cuts in 2025 and another two in 2026, with the Fed moving to near neutral and in no hurry to rock the boat.
The principal “watch out” is a late-cycle wobble in the labor market—momentum has cooled (think Kansas City labor indicators and those pesky negative revisions), and if growth rolls over, policy could turn more decisively dovish.
Cautious optimism
Historically, recessions have elicited around 500 bps of easing, which is another way of saying the asymmetry still points to lower rates if the cycle stumbles. Inflation dynamics are a bit stickier than pre-COVID-19, but the tariff impulse looks like a one-off that the Fed can mostly look through. We continue to anchor on a neutral rate in the mid-3%. On the fiscal front, the near-term picture is less tightening-biased: Tariff revenues and lower yields have helped guide debt/GDP down from roughly 130% to about 113%, even if the long-term sustainability question is still clearing its throat offstage.
We retain our strong conviction in 75 bps of total cuts in 2025 (two more 25 bp cuts), but a humbler conviction of 50 bps of cuts in 2026.
We remain tilted toward long duration in the cash strategies based on our Fed view, while keeping a close eye on liquidity and the timing of potential cash outflows should recession risks materialize. No heroics here: we prefer to keep dry powder and avoid confusing bravery with risk.
Across US rates, we prefer being long duration using the front end of the US Treasury curve. The back end of the curve looks cheap, but not cheap enough, given persistent deficits and the non zero chance of implicit curve-control dynamics under stress. US Treasury supply remains a “versus expectations” story: Despite hefty issuance, the long end has held up year to date as auctions have largely met what the market already braced for, though that support could fade if issuance meaningfully overshoots. The positioning is designed to work if growth softens and frontend rates outperform.
Credit remains resilient, with credit spreads supported by solid balance sheets, steady earnings, and declining net supply. That said, valuations are full, so the better relative value sits outside generic investment grade (IG) and high yield (HY) beta. The Credit Index quality has improved (ratings upgrades), and HY defaults remain low (with a modest uptick in loans), but in a hard-landing scenario, cyclicality can reassert itself quickly. We are tilting our risk budget away from traditional corporate credit and toward more rate-sensitive, higher-quality carry expressions where the compensation per unit of macro risk feels more sensible. In short: enjoy the carry, but don’t overstay the party.
Within securitized and structured credit, we are overweight government agency residential mortgage backed securities (Fannie and Freddie Mac MBS), which offer defensive characteristics in a hard landing scenario thanks to a large low-coupon base and healthy prepayment cushions. We also favor AAA non-agency RMBS, supported by meaningful household equity build-up that provides a fundamental buffer. Reflecting these preferences, we have shifted risk budget from IG corporates toward agency MBS while maintaining diversification within high-quality residential securitized exposures. Think of MBS as the portfolio’s reliable ballast—unflashy, dependable, and exactly what you want when the seas get choppy.
Key risks we’re watching include a deeper deterioration in labor momentum (the swing factor for the cycle), Fed communications constraints if tariff optics complicate the narrative, and the classic hard landing chain—deeper cuts, equity drawdown, softer consumption and confidence, job losses, and a potential drag on AI-linked capex. We’re also attentive to policy and legal volatility around tariffs (there’s headline risk even if it isn’t our base case), the possibility of long-end supply surprising to the upside, and liquidity or cash-flow timing frictions should the economy downshift. None of these, on their own, breaks the soft-landing story, but together they argue for keeping position sizes honest and hedges useful rather than decorative.
Bottom line: Stay diversified, keep a duration overweight, lean into agency MBS and AAA residential securitized credit, and avoid over-concentration in traditional corporate credit beta while the soft-landing remains priced and labor stays the swing factor. We’re constructive—but with seat belts fastened and the tray table up, just in case the captain turns on the turbulence sign.
Originally posted on October 6, 2025 on SSGA blog
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