Fed uncertainty drives up Treasury yields

Weekly fixed income update highlights

• Treasuries, investment grade corporates, MBS, taxable munis and preferreds all retreated.
• High yield corporates, senior loans and emerging markets all advanced.
• Municipal bond yields remained unchanged once again. New issue supply was $10B, and fund inflows were $405M. This week's new issuance is outsized at $13B.

U.S. Treasury yields rose as U.S. Federal Reserve officials signaled caution on near-term rate cuts, pushing December cut odds below 50%. Meanwhile, emerging markets continued their standout 2025 performance, and municipal bonds remained well supported by broad-based demand.

Watchlist

• 10-year Treasury yields rose last week and remain close to our year-end forecast.
• Spread sectors were mixed versus similar-duration Treasuries ahead of the first major economic data since September.
• 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.

Emerging markets lead fixed income 2025 performance

U.S. Treasury yields rose last week, with 10-year yields climbing 5 basis points (bps) to 4.15% and 2-year yields up 4 bps to 3.61%. The U.S. government shutdown ended, clearing the way for the Bureau of Labor Statistics to release delayed economic data, including the September jobs report on Thursday. Separately, Fed officials struck a notably hawkish tone. Perennial hawks like Kansas City's Schmid, Dallas's Logan and Cleveland's Hammack reiterated concerns about elevated inflation. More significantly, typically dovish members - Minneapolis's Kashkari, San Francisco's Daly and Boston's Collins - also suggested uncertainty about a December rate cut. Markets now price less than 50% odds of a December cut, down from 67% the prior week.

Investment grade corporates retreated, returning -0.24% for the week but beating similar-duration Treasuries by 2 bps. Equity market weakness, especially for technology names, weighed on certain components, though financials remained steady. Inflows slowed to $5.1 billion, the lowest in two months. Supply totaled under $30 billion and met healthy demand, with 3.8x average oversubscription and 2.7 bps concessions.

High yield corporates advanced 0.05%, beating similar-duration Treasuries by 13 bps. Senior loans returned 0.09%, their fifth straight weekly gain. BB rated companies returned 0.15% and materially outperformed lower-rated segments. CCC rated bonds fell -0.38% in high yield and -0.51% in loans. Those less-healthy companies may stand to benefit the most from Fed rate cuts, and the reduced odds of near-term cuts has weighed on their performance. High yield funds saw outflows of -$367 million while loan funds had inflows of $388 million. New issuance was down slightly, totaling $8.1 billion in high yield and $5.6 billion in loans.

Emerging markets rebounded, returning 0.04% and outperforming similar-duration Treasuries by 27 bps. Inflows surged to $553 million. New issuance totaled $6.6 billion, entirely from corporate issuers. With six weeks remaining in 2025, emerging markets have returned more than 10% for the year, beating similar-duration Treasuries by over 400 bps and vastly outpacing nearly all other fixed income segments.

Municipal market defined by steady yields and strong demand

Municipal bond yields held steady across the curve last week. The new issue calendar was well received, and fund flows remained positive, including $481 million flowing into exchange-traded funds. This week brings an outsized new issue calendar that should also see strong demand. Reinvestment money still needs deployment, and the following week should see virtually no new issuance due to the Thanksgiving holiday.

The municipal market remains well bid, supported by stable Treasury bond yields and steady inflows. Demand is broad-based - individual investors continue adding exposure while institutional allocations expand. Institutional crossover buyers have become increasingly active, drawn by tax-exempt yields that now rival taxable bond rates. This environment should keep munis well supported through year-end.

In new issuance, Chicago O'Hare International Airport brought $1.2 billion in senior lien revenue bonds (rated NR/A+, subject to AMT). Bonds insured by Build America Mutual (BAM) carried AA ratings and traded at a premium in the secondary market.

High yield municipal bond yields declined slightly on average last week. Most high yield muni funds saw inflows, but a few large withdrawals resulted in overall net outflows of -$81 million across the category. New bond offerings attracted strong buyer interest. Ziegler's record-sized senior living deal for Horizon House was nearly twice oversubscribed and immediately traded at higher prices in the secondary market. Chicago Board of Education bonds traded lower due to excess supply and limited buyer demand.

Emerging markets have returned more than 10% so far this year, vastly outpacing nearly all other fixed income segments.

In focus: Investors seize opportunities in emerging markets debt

For decades, investors demanded a yield premium for allocating capital to emerging markets (EM) debt. Their concerns centered on rising and potentially unsustainable fiscal deficits, high inflation, questionable central bank independence and unwillingness to defend weakening currencies.

Today, traditional boundaries separating developed economies from their EM counterparts are increasingly blurring, creating new opportunities for long-term investors. Concerns over fiscal and monetary policy have been reflected in higher Treasury yields in countries once considered risk-free, such as France and the U.S. Meanwhile, EM economies have benefited from improving fundamentals and a weaker U.S. dollar due to challenges to U.S. exceptionalism and easier Federal Reserve monetary policy. Consequently, we think portfolio allocations should reflect these compelling dynamics rather than adhere to long-standing, rigid geographical classifications.

Investors appear to agree. Improved sentiment has fueled six consecutive months of positive EM debt fund flows totaling $28 billion following April's tariff-related selloff. This recovery has lifted year-to-date flows through 31 October to $16.7 billion. Staying invested despite that downdraft has proven rewarding: year-to-date returns for the asset class (+12.89%) rank among the highest in taxable fixed income, supported by a healthy 6.87% yield.