Aberdeen Investments: 

The US economy has slowed, and tariff-driven inflation is set to rise further, but policy rates will resume their move lower. However, with the Fed under significant political pressure, there is a risk of a slide into fiscal dominance. Medium-term European prospects are supported by coming fiscal expansion.

The US economy has slowed, and tariff-driven inflation is set to rise further, but policy rates will resume their move lower. However, with the Fed under significant political pressure, there is a risk of a slide into fiscal dominance. Medium-term European prospects are supported by coming fiscal expansion.

US activity growth slowed through the first half of the year, as tariff uncertainty weighed on sentiment and deterred firms and households from spending and investment decisions. The labour market is weakening, even relative to the lower breakeven rate of payrolls growth, and further pro-cyclical downward revisions to the jobs data are possible.

However, peak trade uncertainty has probably passed (see Figure 1). Admittedly, the legal battle around the president’s use of the International Emergency Economic Powers Act to impose tariffs creates some residual uncertainty. But the likely landing zone for the new trade regime is seemingly clear. Reduced uncertainty may lead to a mini growth pickup, as pent-up demand is unleashed.

Figure 1: Peak trade uncertainty has passed 

The passthrough of tariffs into inflation has been slower than we expected due to inventory run-down, transshipments, and administrative issues. But as these factors fade, we expect core inflation to rise to 3.6% in coming months.

Real income growth will be squeezed by this higher inflation, weighing on consumption. But ultimately the inflation shock is likely to prove a one-off hit to the price level, especially as a weaker labour market makes it harder for households to negotiate pay increases. All told, we are forecasting US GDP growth of just 1.6% next year and 1.8% in 2027, and inflation averaging 2.9% in 2026 and then 2.1% in 2027. 

But the weakening in the labour market has opened a new downside scenario, in which self-reinforcing stall speed dynamics kick in and the US enters a recession.

At the best of times, the combination of weaker growth and higher inflation would present a policy dilemma for the Federal Reserve (Fed). But with the central bank facing significant politicisation, the policy environment is even more challenging.

We expect the Fed to cut rates by 25bps in September and December, and a further 75bps next year (see Figure 2). It is possible there are dissents in favour of a 50bps cut at the September meeting as Donald Trump’s influence starts to be felt. 

Figure 2: US monetary easing will start again soon 

The big picture risk is that the extent to which the administration is attempting to influence monetary policy makes a profound restructuring of the conduct of monetary policy possible. The president has couched his argument for lower interest rates in terms of reducing government funding costs, increasing our concerns about fiscal dominance. 

So even as front-end rates come down, this could trigger a bond market rout scenario where long maturity bonds sell off sharply. In the limit, a politicised Fed may use its balance sheet to pin down yields through yield curve control. 

In China, the tariff shock has been somewhat mitigated by export strength outside the US. But, with transshipment tariffs now in place, the hit to activity is likely to increase.

By contrast, the easing in European fiscal policy is set to boost growth from the backend of 2026 and into 2027, even if leakages from defence spending are likely to be high. While inflation is likely to fall back below the European Central Bank (ECB)’s target in coming months, the eventual impact of fiscal easing should keep the central bank content about the medium-term path of inflation.So, we think the ECB has reached the end of its cutting cycle, and the next move may be a rate hike at the back end of our forecast horizon. If Europe can combine fiscal easing with some of the supply-side reforms envisioned in the Draghi report, then this could unlock a European spending surge upside scenario. 

We don’t expect a near-term ceasefire in Ukraine because of incompatible negotiation. But in an upside scenario, such a deal could also support European growth via energy prices, sentiment, reconstruction spending, and even greater defence spend depending on the terms of the deal. 

UK inflation is set to increase further in coming months, peaking around 4%, so the risk that the Bank of England keeps rates on hold for an extended period has increased. But on balance we still expect a cut in November and quarterly cuts next year, given the ongoing deterioration in the labour market. Fiscal policy will tighten again in the budget, with a variety of inefficient tax tweaks likely. 

We expect the Bank of Japan (BoJ) to next hike rates in January 2026. An earlier hike is possible, but we think ongoing trade and political uncertainties will see the central bank wait a little longer to better assess domestic inflation trends.

India faces a 50% tariff rate on exports to the US following the additional 25% imposed as punishment for Russian energy imports. We expect a face-saving compromise before year-end. In this environment, the Reserve Bank of India (RBI) would probably keep rates on hold this year. But if such a deal is not made, this would undermine India’s appeal as a supply-chain relocation hub. 

The broader emerging markets outlook has improved as tariff uncertainty has peaked. The EM cutting cycle continues, and we expect more central banks to deliver cuts as the focus shifts from containing inflation to supporting growth, and the Fed resumes easing.

US 

Activity: The underlying pace of growth slowed through first half of the year amid tariff volatility, and our forecasts incorporate subdued growth over the coming few years. Peak tariff uncertainty has passed, and there may be a mini-cyclical pickup from the period of very weak hiring and investment. But higher inflation will weigh on real income growth, which should keep medium-term activity sluggish, and over the longer-run higher tariffs will push down on potential growth. It is possible the slowdown in the labour market triggers stall speed dynamics, tipping the economy into recession, but this is a downside risk for now. 

Inflation: The tariff-driven pickup in inflation has been a little slower than we anticipated, but we still expect core inflation to peak at 3.6% later this year, well above the Fed’s target. The delay in the inflation pickup is explainable in terms of inventories being worked down, transshipments, and other issues collecting tariffs. These are set to pass, and firms are reporting being able to pass on higher input costs to preserve margins. As long as inflation expectations remain anchored, this should be a one-off level shock, with inflation coming down again. But politicisation of the Fed risks entrenching higher inflation. 

Policy: We expect the Fed to deliver two 25bps rate cuts this year, in September and December. It is still plausible that large upside surprises in inflation and/or employment derail these cuts, but it’s also possible that a further slowing in activity leads to more cuts. The medium-term outlook will depend on how much Trump is able to shape the direction of policy. Clearly, the administration is willing to spend political capital on changing personnel and shifting the “Overton window” to lower rates. In the limit this could involve fiscal dominance and yield curve control, but this is still some way off.

What does it mean for Asian investors? 

As US and global interest rates begin to fall, Asian investors are reassessing their cash-heavy allocations. The priorities are clear: stable income, capital growth, lower volatility, and flexibility. These goals are increasingly difficult to achieve through traditional cash or deposit products alone. Many are searching for new solutions that can deliver monthly income, capital preservation, and low drawdown potential, all while allowing a tactical reallocation as markets evolve.

Short-dated credit strategies are emerging as a preferred solution. They offer a compelling middle ground: higher yields than cash, lower volatility than equities, and greater flexibility than term deposits. For investors seeking to step out of cash without stepping into the unknown, this asset class is a compelling destination.

A viable alternative asset class

We think investment-grade short-dated credit offers optimal balance in terms of yield enhancement above cash and stability, facilitated by the key features of low credit risk and low duration.

As for stability, as shown below, the ICE BofA 1-5 Year Global Corporate Index recorded just two negative total return over the last 28 calendar years (see Figure 3). The year 2022 was one of historic negative returns across fixed income; however, even then, short-dated credit still outperformed indices of other maturities, such as the ICE BofA Global Corporates Index, which fell over 16%. 

Figure 3: Global corporate short-dated index annual total returns (1997-2024)

_{Source: Morningstar Direct, based on USD hedged index data, September 2025}

We believe our short-dated credit strategy, which aims to deliver a yield enhancement over cash, while keeping volatility and drawdowns firmly in check, is designed to be an all-weather solution for investors looking to ‘step out of cash’.

The strategy invests in a global short-dated corporate bonds with an outcome focused goal to deliver yield above cash, and without being benchmark-constrained, offering a T+1 settlement for quick access. We seek stability by investing in high-quality securities, resulting in an average portfolio credit rating of A-, and a duration of less than two years. In addition, we allocate around 35% of the portfolio to bonds maturing within one year – a segment we believe offers outstanding risk-adjusted yields. These securities behave more like money market assets, with extremely low volatility, yet they’re often excluded from traditional short-dated bond indices.

Final thoughts…

US interest rates look set to fall, prompting investors to reconsider their cash allocations. With inflation still elevated, traditional income strategies are under pressure. Against this backdrop, the global investment grade short-dated credit strategy offers a low-volatility, yield-enhancing alternative – combining stability, access, and global diversification. In short: it’s a compelling solution for investors looking to ‘step out of cash’ without stepping into uncertainty. 

Written by Aberdeen Investments, on 15 September 2025 before the announcement by Fed about the rate cut