Treasury yields fall as trade policy remains in focus

Weekly fixed income update highlights

• Treasuries, MBS, investment grade and high yield corporates, preferreds, emerging markets, senior loans and CLOs all had positive returns.
• Municipal bond yields ended the week lower. New issue supply was $10.7B, and fund inflows were $562M. This week’s new issuance is expected to be $18.4B.

U.S. Treasury yields fell and spread sectors outperformed as the U.S. tariff outlook improved further. Overall, risk assets rallied, and the associated odds of near-term U.S. Federal Reserve rate cuts declined.

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Watchlist

• Treasury yields moved lower, and we continue to expect elevated volatility, a wider trading band and a modest rally from current levels.
• Spread sectors gained substantially versus Treasuries as the U.S. deferred threatened tariffs on Europe.
• We expect the technical environment for municipal bonds to improve as the year progresses.

Investment views

We believe fixed income yields generally present one of the best entry points in a generation, creating attractive income opportunities.

Downside risks are material, despite strong fundamentals, with tariffs likely to compress consumer spending and weigh on business fixed investment. 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.

Strong high yield corporate performance continues

U.S. Treasury yields fell last week, with 10-year yields ending -11 basis points (bps) lower at 4.40%. 2-year yields declined -9 bps, resulting in modest curve flattening. Trade and tariff developments dominated attention. To start the week, the U.S. and the European Union reached an agreement to delay President Trump’s proposed 50% bilateral tariff rate until 9 July. Then, on Wednesday, a U.S. court ruled that most of President Trump’s tariffs were illegal. Though the court initially ordered a halt to the collection of tariffs, an appeals court quickly stayed that decision. The Supreme Court is likely to ultimately weigh in, with a ruling possible by the end of July. Overall, risk assets rallied in response to the reduced threat of higher tariffs, and the associated odds of near-term Fed rate cuts declined. Markets now imply two rate cuts this calendar year, down from four priced in at the end of April.

Investment grade corporates rallied strongly, returning 1.11% for the week and beating similar-duration Treasuries by 32 bps. The asset class was close to flat in total return terms in May, as Treasury yields moved higher overall, but had excess returns of 127 bps. Inflows were steady at $3.8 billion for the week, close to the recent average. New issuance remained healthy at $25 billion. Those deals saw oversubscription rates averaging 4x and new issue concessions of just 0.6 bps, well below the average of around 3.6 bps year-to-date.

High yield corporates continued to perform well, returning 0.74% and beating similar-duration Treasuries by 39 bps. Senior loans returned 0.31%. Both asset classes saw volatility in tariff-related sectors like retail, amid the dueling tariff headlines. Inflows were steady, with $242 million and $296 million entering the high yield and senior loan markets, respectively. New issuance was also stable, with around $2.5 billion pricing in both markets.

Emerging markets joined the rally, returning 0.62%, but the asset class lagged similar-duration Treasuries by -7 bps. Outflows resumed, with -$36 million exiting the market. There was almost no new issuance, with the notable exception of Argentina, which continued its recent march toward normalization by issuing around $1 billion of five-year, peso-linked bonds to foreign investors.

Municipal bonds offer value at current yields

Municipal bond yields ended lower last week. Short-term muni yields declined -6 bps and long yields finished -2 bps lower. New issuance was subdued due to the holiday-shortened week in the U.S. Fund flows per Lipper were positive for the seventh straight week, including exchange-traded fund inflows of $247 million. This week’s new issue market is expected to be the second largest ever for munis, and it’s unlikely to be fully absorbed.

We believe municipal bonds offer value at current yields, the highest in almost two years. The muni market has sold off along with Treasuries, and relentless muni bond new supply has also pushed yields higher. We see some light at the end of the tunnel, as $140 billion of reinvestment money is coming due from June to August. However, muni new issue supply is expected to remain outsized, and we expect these yields to continue through the summer.

Dormitory Authority State of New York (DASNY) issued $1.1 billion New York University revenue bonds (rated Aa2/AA-). Underwriters lowered the yield on the shorter maturities, as that part of the deal was so well received.

The high yield municipal market remains firmly bid from a combination of reinvestment flows and net positive fund flows. We are monitoring 17 deals in this week’s robust new issue calendar. The market is uncharacteristically unenthusiastic on high beta names given the attractive taxable-equivalent yields available as we enter the typical season of technical strength.

This week’s new issue market is expected to be the second largest ever for munis, and it’s unlikely to be fully absorbed.

In focus: TIPS: a top fixed income performer

Treasury Inflation Protected Securities (TIPS) have performed well this year, and we think their near-term outlook appears solid, especially if inflation forecasts stay high.

As for fundamentals, we believe inflation, which has cooled in recent months, will heat up temporarily amid elevated trade war concerns. Therefore, we favor shorter-dated TIPS. Longer-term break-evens — the yield difference between nominal Treasuries and TIPS of similar duration, and a gauge of expected future inflation rates — remain rangebound, reflecting a longer-term return to trend inflation and growth.

Regarding market technicals, fund flows have been supportive in 2025 but have leveled off. Investors have tracked economic data releases, boosting TIPS allocations when gauges of inflation and growth perk up. Greater issuance of TIPS, which we anticipate, along with cooler inflation, could hinder the asset class.

Although TIPS valuations overall are neutral to positive (intermediate- to longer-term break-evens hover in the middle of a well-defined range), we think short-term TIPS offer value. Long-term Treasury yields have jumped due to an increase in the term premium, reflecting heightened uncertainty over trade and the outlook for U.S. debt levels, among other factors. Shorter-dated TIPS have retraced from rich breakeven levels – and long-term yields are higher – offering a nice entry point into the asset class in general.