Bond markets show strength after the Fed cuts

Weekly fixed income update highlights

• Treasuries, investment grade and high yield corporates, MBS and preferreds all retreated last week amid the move higher in rates.
• Senior loans and emerging markets advanced.
• Municipal bond yields increased. New issue supply was only $6B, and fund inflows were $720M. This week's new issuance ramps up to $13B.

Fixed income markets responded to relatively hawkish U.S. Federal Reserve signals last week, with Treasury yields rising and the curve flattening. Credit markets outperformed Treasuries across sectors, while municipal bonds remained well bid heading into year-end.

Watchlist

• 10-year Treasury yields rose last week and are close to our year-end forecast.
• Spread sectors broadly outperformed similar-duration Treasuries amid the selloff in rates.
• 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.

Credit markets navigate higher yields after Fed meeting

U.S. Treasury yields moved higher last week following hawkish signals from Fed Chair Powell. The Fed cut interest rates by 25 basis points (bps) as expected, but Powell's rhetoric at the press conference was notably more hawkish than in previous communications. Treasury yields rose and the curve flattened as a result, with 2-year yields up 9 bps and 10-year yields up 8 bps. Separately, the U.S. federal government shutdown continues, with betting markets implying another two weeks before resolution. The economic data calendar remains light as a result, though this week's privately issued ISM surveys should provide a gauge of economic activity in October.

Investment grade corporates retreated, returning -0.85% for the week, though they outperformed similar-duration Treasuries by 21 bps. Post-Fed Treasury movements dominated price action, while the technical backdrop was weak. Inflows slowed slightly to $6.2 billion, nonetheless remaining at healthy levels. Supply was heavier than expected at almost $77 billion. Deals continued to meet solid demand, averaging oversubscription rates of 3.8x, but new issue concessions were materially wider than recent trends at 2.1 bps.

High yield corporates were nearly flat, returning -0.09% and outpacing similar-duration Treasuries by 35 bps. Senior loans returned 0.24%. Since loan yields are floating-rate, the more-hawkish Fed stance supported yield levels, which ticked up to 7.87%, matching their highest levels since August. High yield fund inflows totaled $459 million, while loan funds experienced outflows of -$132 million. New issuance picked up in both markets, totaling $4.2 billion and $6.9 billion across high yield and loans, respectively.

Emerging markets continued to advance, returning 0.59% and outperforming similar-duration Treasuries by 36 bps. Spreads broadly tightened across sovereigns and corporates, with high yield segments generally outperforming. Notable gains in Argentina contributed to this performance, where benchmark 10-year U.S. dollar bonds surged almost 14 points following market-friendly election results. Inflows across emerging market funds continued, though they decelerated to $564 million. New issuance was steady at $8.6 billion.

The municipal bond market is well-positioned for year-end

The municipal bond yield curve ended higher last week, with short- and long-term yields rising 2 bps and 5 bps, respectively. New issue supply was low and well received. Fund inflows included $2.5 billion into exchange-traded funds. The outsized ETF figure likely reflects investors repositioning short-term municipal holdings further out on the curve, as money market accounts showed outflows of -$418 million. This week's new issue supply is expected to increase and should be well received.

The muni market remains well bid, supported by a stable Treasury market and manageable new issue supply in recent weeks. Demand remains strong from both individual and institutional investors and should continue as investors deploy 01 November reinvestment proceeds. With 01 December approaching - an outsized month for reinvestment - we expect munis should remain well bid through year-end.

The Chicago Board of Education issued $1 billion in unlimited tax GO refunding bonds (rated NR/BB+). The deal was largely well received, though balances remained in the account at week's end. Underwriters should clear these positions in a timely manner.

High yield municipal bond yields increased just 1 bps last week as the market displayed resilient demand. Fund flows stalled last week, but an exchange-traded fund conversion may have distorted the data, as actual market demand remained robust. This week should bring a typical new issue calendar, with Nuveen tracking a diverse set of 15 new deals.

Outsized December reinvestment flows should keep munis well bid through year-end.

In focus: The Fed cuts but lets the hawks out

As anticipated, the Federal Reserve lowered interest rates for the second consecutive meeting, reducing the fed funds rate by 25 basis points (bps) to a new target range of 3.75%-4.00%. This decision aligns with the Fed's previously published dot plot of rate expectations.

Although the central bank's policy statement was largely unchanged compared to October, Chair Powell leaned hawkish in his press conference. He indicated that a rate reduction in December "is not a forgone conclusion" as "we just don't know what we're going to get" in terms of economic data between now and then. If the Fed remains in a data blackout because of the government shutdown, Powell said that uncertainty "could be an argument in favor of caution about moving."

The Fed also announced the end of its balance sheet runoff policy, effective 1 December. Maturing Treasuries will be reinvested in new Treasuries, and maturing mortgage-backed securities will be reinvested in Treasury bills. These actions are meant to stabilize the level of bank reserves and reduce the risk of dislocations in overnight lending markets.

We still expect two rate cuts (totaling 50 bps) through mid-2026, with one possible next month if employment data is released and signals further weakness. The government could publish three job reports (for September, October and November) in quick succession. In our view, the health of the labor market will determine the pace and path of any near-term easing.