Economic crosscurrents drive Treasury yield turbulence

Weekly fixed income update highlights

• Treasuries, taxable municipals and agency MBS - rate sensitive segments of the market - retreated.
• Investment grade and high yield corporates, preferreds, senior loans, CLOs and emerging markets gained.
• Municipal bond yields remained essentially unchanged. New issue supply was $13.4B, and fund outflows were -$108M. This week’s new issuance is $7.9B.

U.S. Treasury yields exhibited significant volatility amid mixed economic signals last week, with the yield curve steepening. Despite rate fluctuations, credit sectors demonstrated remarkable resilience and the municipal market remained strong.

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Watchlist

• Treasury yields rose modestly but remain near our year-end targets.
• Spread sectors generally outpaced Treasuries as rates edged higher and risk assets outperformed.
• We expect the technical environment for municipal bonds to improve over the remainder of the year.

Investment views

We believe fixed income yields generally present a very attractive entry point, creating compelling income opportunities.

Downside economic risks are material, despite strong fundamentals, with tariffs likely to compress consumer spending and weigh on business fixed investment. But a U.S. recession is not our base case.

Risk premiums may widen further, with entry points likely to become more attractive over the coming quarters. Duration is likely to reassume its role as a growth hedge.

Key risks

• Tariffs further undermine consumer and business confidence, raising prices while weighing on sentiment and activity.
• Inflation fails to continue moderating as expected, weighing on asset prices.
• Geopolitical flare-ups intensify around the world.

Investment grade corporate spreads reach multi-decade lows

U.S. Treasury yields remained volatile last week, with the yield curve steepening further and partially offsetting earlier month gains. The 10-year yield rose 4bps to 4.32% while the 30-year climbed 7bps. The Fed-sensitive 2-year yield finished marginally lower. Markets fluctuated throughout the week. Yields initially declined following July's CPI report, which showed core goods prices rising less than feared despite tariff impacts. This positive momentum continued with dovish U.S. Federal Reserve commentary and Treasury Secretary Bessent's remarks on monetary easing. However, sentiment reversed Thursday after the PPI revealed surprising inflationary pressure, posting a 0.9% monthly gain - the fastest increase in three years. This unexpected strength triggered a yield curve steepening, with longer-term rates rising significantly.

Investment grade corporates outperformed, returning 0.19% for the week and beating similar-duration Treasuries by 40 bps. Spreads continued to narrow and ended the week at 73 bps, the lowest level in decades. New supply activity was modest at $33.2 billion in new deals, falling shy of expectations. Deals were oversubscribed with minimal concessions. Looking forward, market expectations remain for a busy September despite the uptick in rate volatility. Issuers are taking advantage of tight credit spreads and a busy month of issuance.

High yield corporates gained, returning 0.27% and outperforming similar-duration Treasuries by 23 bps. Spreads tightened by 4 bps and have retraced almost all of the widening from earlier in the month. Within high yield, lower quality credits outperformed, with CCC outpacing B and BB. From a supply perspective, it was another active week with approximately $9.5 billion pricing. Separately, senior loans returned 0.05%.

Emerging markets outperformed, returning 0.51% and outpacing similar-duration Treasuries by 66 bps. Markets were supported by expectations for Fed rate cuts and global central bank easing. Favorable currency dynamics provided additional momentum. Dollar weakness continued benefiting global emerging markets broadly. Inflows totaled $1.1 billion, up from $386 million the week prior. Overall, spreads on emerging markets sovereign debt tightened once again, moving inside pre-Covid tights for the first time since early 2020.

Municipal bond yield curve remains stable

The municipal bond yield curve ended last week basically unchanged, with short-term yields decreasing -2 bps and long-term yields increasing 2 bps. Most new issue deals were well placed. Fund flows turned slightly negative overall, while exchange-traded funds saw inflows of $15 million. This week's new issue is manageable and should be well received.

The municipal bond market remains strong, supported by Treasury market strength, as municipal yields are typically priced relative to Treasury benchmarks. Approximately $55 billion in August reinvestment flows are entering the market amid heightened supply. We anticipate municipals will trade within a narrow range through month-end.

Municipal bonds present compelling value from both historical and ratio perspectives, with intermediate-term issues delivering approximately 4% tax-exempt yields and long-term bonds reaching 5%. Investors seeking higher returns may find additional yield opportunities in the high yield sector.

The Port Authority of NY and NJ issued $1.1 billion consolidated bonds (rated Aa3/AA). The deal was well received. Underwriters lowered yields on the long bonds by 5 bps upon final pricing. Short bonds were cheapened 2 bps to clear the market.

High yield municipal bonds experienced modest outflows last week, likely representing early tax loss harvesting. Nevertheless, new issuance continues to find buyers, though at elevated yields typically ranging from 6.5% to 7.0%. The successful remarketing of Brightline commuter bonds provided market reassurance, while a more than $300 million new issue for a Florida startup continuing care retirement community demonstrated robust demand, trading higher in secondary markets and confirming ongoing investor appetite for risk assets.

Emerging markets were supported by expectations for Fed rate cuts and global central bank easing.

In focus: Senior loans continue to make their case

Among liquid taxable fixed income sectors, senior loans are both the highest-yielding (7.9%) and least volatile, as measured by standard deviation of returns. Investors are taking notice, as fund flows have been positive for 16 consecutive weeks.

We continue to see value in higher-quality loans, which are currently yielding between 6.0% and 7.5%. Moreover, as of late July, a large cohort of loans ($225 billion in total) was trading below par (around $95), with a median price of $85 and yield to maturity (3 years) of approximately 16%. These levels offer significant yield and price appreciation potential.

Investing within this cohort requires selectivity, including a disciplined approach to credit underwriting and a focus on actively managing credit risk. And while the default rate for 2025 is expected to hover slightly above long-term averages, active managers may be able to both cushion against credit deterioration and go on the offensive when fundamental value is mispriced.

Regarding the impact of a Federal Reserve rate cut in September, which markets now anticipate, we expect base rates to remain elevated - a boon for senior loans - compared to the near-zero rate environment that prevailed for most of the last 15 years. In our view, still-high rates, resilient fundamentals and supportive technicals should keep the asset class well positioned through the rest of 2025.