Treasury yields rise, and the Fed remains patient

Weekly fixed income update highlights

• Treasuries, investment grade corporates, MBS and CMBS had negative total returns.
• High yield corporates, preferred securities, senior loans, emerging markets and CLOs all had positive total returns.
• Municipal bond yields ended the week mixed. New issue supply was $13B, and fund inflows were $1.1B. This week’s new issuance is expected to be $13.8B.

U.S. Treasury yields increased amid positive U.S. economic data, progress on trade negotiations and hawkish commentary from the U.S. Federal Reserve. Markets are now pricing in just 2.7 Fed rate cuts for 2025.

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Watchlist

• Treasury yields moved higher, and we continue to expect elevated volatility, a wider trading band and a modest rally from current levels.
• Spread sectors gained versus Treasuries amid better economic data.
• 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 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.

High yield corporate performance led by lower-rated segments

U.S. Treasury yields rose again last week, with the 10-year yield ending 7 basis points (bps) higher at 4.38%. 2-year yields rose by a similar magnitude. U.S. economic data was generally healthy, headlined by a surprising uptick in services sector business sentiment. Wednesday’s Fed meeting resulted in no changes to policy, although Chair Powell suggested that the central bank will remain patient as it evaluates the impact of tariffs on its employment and inflation mandates. Markets have gone from pricing more than 4 rate cuts this year as of the end of April, to pricing just 2.7 cuts as of Friday’s close. That movement reflects the better economic outlook, Powell’s hawkish tone and signs of progress on tariffs. President Trump announced a trade deal with the UK and a temporary agreement with China.

Investment grade corporates retreated alongside Treasury yields, returning -0.10% for the week, but the asset class outperformed similarduration Treasuries by 21 bps. Spreads tightened 3 bps to 99 bps, the tightest since 2 April and now just 6 bps away from their closing level before 2 April. Inflows accelerated substantially at $3.2 billion, while supply was also larger than expected at $43.2 billion. Despite that upside surprise, demand remained strong, and new issue concessions averaged 2.3 bps. This is still well below the prior year-to-date average.

High yield corporates advanced, returning 0.15% and beating similar-duration Treasuries by 26 bps. Most of that rally was driven by lower-rated segments, with CCC rated corporates returning 0.58% versus a 0.13% rally for BB rated corporates. That outperformance mostly closed the gap since 2 April. Lower-rated names led the selloff amid the tariff concerns and have led the subsequent rally, such that relative performance between segments is now close to neutral. Senior loans returned 0.38%. Both high yield and loans enjoyed inflows, of $1.6 billion and $59 million, respectively.

Emerging markets outperformed, returning 0.14% and outpacing similar-duration Treasuries by 41 bps. As in U.S. corporates, returns were driven by lower-rated segments, with high yield sovereign spreads tightening 33 bps versus only 9 bps for investment grade names. Emerging markets funds also enjoyed a large acceleration in inflows totaling $481 million. New issuance was healthy, with $6.7 billion pricing, averaging oversubscription rates of 3.5x.

Muni bonds are cheap enough to attract crossover buyers

Municipal bond yields ended last week mixed, with the short-term yields declining by 3 bps and longterm yields increasing by 2 bps. The new issue calendar was priced to sell and deals were well received. Fund flows were positive for the second consecutive week, including exchange-traded inflows of $387 million. This week’s new issue calendar is expected to be priced to sell, and deals should clear the market.

The municipal market currently represents fair value,even though new issue supply has been relentless and is expected to continue. However, approximately $120 billion of reinvestment money should come due through the summer, improving supply/ demand equilibrium. We would view any selloff due to outsized supply as a potential buying opportunity. Munis are cheap enough now to attract crossover buyers who offer access to a large pool of cash.

State of Connecticut Health and Educational Facilities Authority for Yale University issued $500 million revenue bonds (rated Aaa/AAA). The deal comprised three separate put bonds, which were all well received. Each traded in the secondary market at a premium to where they were originally issued.

The high yield municipal market has been stabilizing recently with accelerating fund inflows. The new issue calendar was heavy last week, and Nuveen tracked 19 deals. Deals were consistently oversubscribed, even deals Nuveen chose to pass on for credit reasons. We are identifying many secondary opportunities where yields have not recovered from the dislocations caused by April’s explosion of volatility. But we expect yields and credit spreads to compress over the coming weeks now that demand has improved.

Investment grade corporate spreads tightened to 99 bps, the tightest since 2 April.

In focus: Fed emphasizes patience over preemption

Citing continued uncertainty over the magnitude and persistence of tariffs, last week the Federal Reserve held its target fed funds rate range at 4.25%4.50%. However, the central bank signaled that its next move is likely to be a rate cut later this year.

The Fed, in its policy statement, stated that “uncertainty about the economic outlook has increased further” and that “the risks of higher unemployment and higher inflation have risen.”

In his press conference, Chair Jay Powell emphasized that, given the high level of uncertainty and positive economic fundamentals, there is no urgency to cut rates in the near-term. He said, “the right thing to do is await further clarity” and “we can be patient,” especially because it remains to be seen exactly how the “scale, scope, timing, and persistence of the tariffs” will evolve. Powell explicitly stated that this is “not a situation where we can be preemptive,” suggesting that the Fed will wait to see actual deterioration in the labor market data before feeling compelled to lower rates

We anticipate two 25 basis point rate cuts this year, followed by three cuts in 2026. These forecasts are based on our macroeconomic outlook and a probabilityweighted view on the outlook for tariffs. But if tariffs end up higher than our models suggest, the Fed could loosen policy more aggressively (and vice versa).