Strong data drive yields and pressure credit

Weekly fixed income update highlights

• Treasuries, investment grade and high yield corporates, taxable municipals, MBS and preferreds posted negative returns.
• Senior loans, CLOs and emerging markets produced modest gains.
• Municipal bond yields increased. New issue supply was outsized at $15.7B, and fund outflows were -$18M. This week's new issuance is modest at $7.8B.

Strong economic data pushed U.S. Treasury yields higher last week, with the curve bear-flattening as short-term rates rose more than long-term yields. The move pressured most credit markets, though emerging markets gained. Municipal bonds remained well-supported despite modest yield increases.

Watchlist

• 10-year Treasury yields rose last week.
• Spread sectors were mixed versus similar-duration Treasuries.
• 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.

Treasury yields rise, pressuring broader credit markets

The U.S. Treasury yield curve bear-flattened last week as yields less than 10 years rose while 20- and 30-year yields remained largely unchanged. 2-year yields increased 7 basis points (bps) to 3.64%, and 10-year yields climbed 5 bps to 4.18%. The move partially reversed the prior week's decline following the Fed's 25 bps rate cut. Investors reassessed expectations for additional rapid rate cuts after stronger-than-anticipated economic data: Second quarter GDP was revised upward to 3.8%, August new single-family home sales reached their highest level in 3.5 years and weekly jobless claims came in below expectations.

Investment-grade corporates declined, returning -0.40% for the week and underperforming similar-duration Treasuries by -14 bps. Spreads widened, reversing several weeks of consecutive tightening. Heavy new issuance and equity market weakness drove the underperformance. Despite this, inflows remained strong at $7.9 billion - the highest weekly level for September. New supply totaled $54 billion, well above the $35 billion forecast. The preferred securities sector also struggled, returning -0.43% and lagging similar-duration Treasuries by -21 bps.

High yield corporates underperformed as well, returning -0.23% and trailing similar-duration Treasuries by -7 bps. Lower-quality credits showed relative resilience, with CCCs outperforming single Bs, which in turn outperformed BBs. Senior loans returned 0.02%. Issuance was robust in both sectors, with $18 billion pricing in high yield ($49 billion for the month, the busiest September on record) and $18 billion in loans. Flows were mixed, showing -$365 million in high yield fund outflows and $162 million in loan inflows.

Emerging markets posted gains, returning 0.39% and outperforming similar-duration Treasuries by 64 bps. Sovereign spreads tightened -6 bps, led by high-yield spreads that compressed -12 bps. Corporate spreads also tightened modestly, with high yield and investment grade spreads performing relatively evenly. Inflows accelerated to $1.3 billion, with hard currency funds decreasing modestly to $621 million while local currency inflows increased materially to $690 million. New supply remained similar to the prior week at $14.2 billion, primarily from investment-grade issuers.

Municipal bond yields rise amid strong demand

Municipal yields increased last week, with short- and long-term rates rising 26 basis points (bps) and 4 bps, respectively. New issue supply was outsized but well received. Weekly municipal fund flows turned slightly negative, including -$65 million flowing out of exchange-traded funds. This week's new issue supply is modest and should be well received.

The municipal market remains well bid. The Treasury market remains stable, which helps support the municipal market. Although municipal supply has been outsized all year, new issuance has been manageable in recent weeks. Finally, municipal bond yields remain attractive - investors can still purchase tax-exempt intermediate bonds at 4% yields and long-term bonds at 5%. We expect these yield levels to remain available through year-end.

The Texas Water Development Board's recent $1.8 billion water revenue bond issuance (rated AAA) exemplifies market conditions. The deal included 4.5% coupon bonds due in 2045 priced at par, demonstrating that quality tax-exempt bonds yielding 4% or more remain available, depending on maturity selection.

High yield municipal bonds maintained momentum during the strongest September for the muni market since 2009, though performance moderated as inflows slowed and supply increased. Unlike investment grade funds, high yield munis posted positive inflows of $136 million last week, evenly split between mutual funds and ETFs. Year-to-date, 58% of high yield muni fund flows have gone into mutual funds versus only 25% for investment grade funds. Technical indicators were mixed, with World Trade Center 5S declining 1 bps while Puerto Rico Sales Tax Financing Corporation (COFINA) 5S and Buckeye 5S increased 5 and 14 bps, respectively. This week's lighter supply calendar should create supportive conditions.

High yield corporate issuance hits $49 billion for the month, the busiest September on record.

In focus: Securitized assets may enhance portfolios

Adding securitized sectors such as mortgage-backed securities (MBS), asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS) to a fixed income portfolio may help boost yield and total returns.

These sectors currently rank among the highest-yielding investment grade fixed income options, with yields ranging from 4.23% to 4.76% as of 26 September. Securitized credit also offers lower rate volatility thanks to its shorter duration and limited exposure to tariff-related volatility.

CMBS continues to recover from a challenging 2022 and 2023. Commercial real estate values have rebounded, and refinancing has proved easier in most property type subsectors, including retail, multifamily and industrial. However, office space still faces challenges, a situation unlikely to improve much until supply and demand reach better balance.

Agency-issued MBS, a mainstay of the fixed income market, delivers higher yields than Treasuries and stable prepayment rates. For some investors, this asset class represents an optimal combination of credit, liquidity, spread and relative immunity from tariff impacts.

ABS provides the broadest diversification within securitized credit, with dozens of collateral types and both investment grade and high yield exposure. As a result, they may offer lower correlations to other assets in a broader fixed income portfolio.