Dovish Fed signals boost fixed income markets

Weekly fixed income update highlights

• Treasuries, MBS, investment grade and high yield corporates, taxable munis and emerging markets advanced.
• Senior loans and preferreds retreated.
• Municipal bond yields remained unchanged once again. New issue supply was outsized at $14.1B, and fund inflows were $130M (after accounting for a fund adjustment). This week's new issuance is only $1.1B.

U.S. Treasury yields declined as expectations for U.S. Federal Reserve rate cuts moved higher at the end of the week, driving a rally. Investment grade and high yield corporate credit spreads widened despite positive technicals, while municipal bonds remained well bid.

Watchlist

• 10-year Treasury yields fell last week and remain close to our year-end forecast.
• Spread sectors broadly lagged similar-duration Treasuries amid mixed U.S. labor market data.
• 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.

Treasuries rally while credit spreads widen

U.S. Treasury yields fell last week, after rising in each of the three prior weeks, with the 10-year Treasury yield declining -8 basis points (bps) to 4.07% and 2-year yields falling -10 bps to 3.51%. The move was driven by repricing of Fed rate cut expectations. After hawkish signals from regional Fed presidents pushed the odds of a December rate cut to as low as 32%, NY Fed President Williams argued in favor of a cut, sparking a sharp reversal to roughly 75% odds. That shift helped Treasuries rally across the curve. Separately, the long-awaited September jobs report mostly met expectations, with job creation accelerating to 119,000 - nearly double the three-month pace - though the unemployment rate rose to 4.4%, a new cyclical high.

Investment grade corporates gained 0.40% for the week but lagged similar-duration Treasuries by -15 bps. Spreads widened by around 3 bps to 85 bps, the widest level since June, though still relatively tight historically. The technical backdrop was mixed: inflows picked up to $6 billion, but supply was heavier than expected at $45 billion - roughly 50% above consensus. New deals were nevertheless well-received, averaging 4x oversubscription and tighter concessions than the prior week at 1.3 bps on average.

High yield corporates were nearly flat, returning 0.03%. The asset class underperformed similar-duration Treasuries by -33 bps, with spreads widening 10 bps. Senior loans returned -0.09%, as spreads widened 4 bps. Both asset classes experienced outflows, totaling -$333 million and -$89 million from high yield and loan funds, respectively. Supply remained healthy at $6.4 billion in high yield and $21.1 billion in loans.

Emerging markets were mixed, returning 0.07% but lagging similar-duration Treasuries by -46 bps. Spreads widened by 4 to 7 bps across sovereign and corporate markets. Inflows picked up to $675 million, bringing the year-to-date total to nearly $24 billion. Primary market activity was relatively busy at $15.5 billion, mainly in the high grade, with deals well-digested, at oversubscription rates of 3.5x.

The muni market is supported by strong technical factors

The muni yield curve remained essentially unchanged last week, with short-term yields flat and long-term yields rising 2 bps. New issuance was outsized but well received. This week's calendar is very light due to the Thanksgiving holiday and should be easily absorbed.

The muni market remains well bid, supported by the strong government bond market and favorable supply/demand dynamics. December's new issue calendar should be relatively light due to holidays, while demand remains robust from both individual and institutional buyers. Reinvestment flows of $42 billion coming 01 December will need deployment, with January 1 - typically munis' highest reinvestment month - following closely. Munis should remain well bid through year-end.

Ascension Health Alliance (Ascension Senior Credit Group, Indiana) issued $1.75 billion revenue bonds (rated Aa3/AA). The deal included 5% coupon bonds due in 2035 priced at 3.21%, with some bonds trading at a premium in the secondary market at 3.18%.

The high yield municipal market absorbed substantial new issuance last week in a pre-holiday push, including the highly anticipated resolution of Brightline West's impending default. The market ended the week on a positive note. Despite negative fund flows concentrated in select platforms, new issues were well absorbed. A limited $500 million pre-pay gas securitization backed by Citadel was heavily oversubscribed and traded 30+ bps tighter in the secondary market. Brightline West announced a successful restructuring to redeem 28% of outstanding bonds with trustee-held funds while backing the remaining 72% with a U.S. Department of Transportation loan, additional equity, senior debt and an investment grade rating requirement.

December's muni bond new issue calendar should be relatively light, while demand remains robust from both individual and institutional buyers.

In focus: The eurozone economy zips ahead

Thanks to contributions from the manufacturing and service sectors, the eurozone economy enjoyed its best month in nearly 2½ years in October, ending months of stagnant growth.

Europe's continued macro improvement will turn on Germany's massive investment plan, which runs through 2029. This program will channel around €800 billion into defense and €300 billion into infrastructure, with additional green and social spending aimed at lifting growth and improving strategic autonomy.

Markets appear to be underestimating the speed of Germany's implementation and its multiplier effect. Defense orders are proceeding apace with few bottlenecks, and infrastructure investment should accelerate through 2026, fueled by Next Generation EU funds — the European Union's largest fiscal program.

This upswing in spending repositions Europe from a "policy taker" to a "growth maker," as the European Central Bank remains cautiously hawkish amid inflation that hovers near its 2% target. With consumer prices under control for the time being, we believe the ECB has completed its rate cutting cycle and could hike rates by 25 basis points, to 2.25%, by the second half of 2026. Meanwhile, 10-year bund yields could rise toward 3% (from 2.69% on 21 November) over the rest of the quarter, lifting the euro to $1.22 (from $1.15) as fiscal expansion supports above-trend growth.