Investors retreat to safety as AI stumbles

Key takeaways

• Hotter inflation data and AI spending concerns triggered an equity selloff, while Treasuries rallied on safe-haven demand.
• Quality dispersion defined credit: BB rated high yield held steady while CCC credits bore the brunt of losses.
• This week’s credit widening stayed concentrated in AI-linked names, a sign of idiosyncratic stress rather than broad deterioration.

Market recap

Global markets softened as an AI-led tech pullback tempered earlier resilience. U.S. equities retreated from record highs after hotter-than-expected inflation data and concerns over debt-fueled AI spending triggered a sharp selloff in AI and AI-adjacent names. Treasuries swung both ways: Yields rose initially after the CPI print, then reversed as AI concerns turned sentiment risk-off, sending investors toward safe havens. The long end led the rally, flattening the yield curve.

That rate rally lifted total returns across most of fixed income, with municipals and Treasuries out front. High yield, senior loans and lower-rated collateralized loan obligations were the exceptions, posting losses as AI and data center stress hit the bottom of the quality spectrum. BB rated paper held firm, while CCC credits bore the brunt.

Fixed income outlook from this week’s activity

We expect one more U.S. Federal Reserve rate hike by year-end, then an extended hold through 2027 – a less hawkish path than markets currently price. The outcome hinges on how the energy shock feeds through to core inflation, along with services activity and labor data. This week, however, brings a quiet domestic calendar.

Credit fundamentals remain sound: This week’s widening stayed concentrated in AI-linked names rather than signaling broad deterioration, and with spreads near three-year averages, we read the move as idiosyncratic, not systemic. We favor high-quality income and, in municipals, longer duration over Treasuries. We forecast the 10-year Treasury at 4.95% by year-end 2026 and 4.75% by end-2027, with the 2-year at 4.70% and 4.50% respectively.

Weekly fixed income snapshot

U.S. Treasuries

Yields fell across the curve, with longer-term rates dropping more than short-term rates – a pattern known as a bull flattener. The week was volatile: yields initially rose on a hotter-than-expected CPI print, briefly pushing the 10-year above recent highs, before reversing sharply as AI-related equity weakness drove safe-haven demand.

The 2-year fell 8 bps to 4.71%, the 5-year 15 bps to 4.87%, the 10-year 17 bps to 5.08%, the 20-year 18 bps to 5.47% and the 30-year 17 bps to 5.42%.

Tax-exempt municipals

Municipals were among the strongest performers, as their long duration profile benefited from the broad rate rally. With the index yielding 4.48% and high yield municipals at 6.02%, absolute yields remain at levels that have historically attracted buyers. We continue to view technical weakness as an opportunity to add high-quality duration, and favor longer duration in municipals over Treasuries.

The Bloomberg Municipal Index returned +1.31%.

Taxable municipals

Taxable municipals posted a strong gain, as the rate rally benefited the sector’s long duration profile. Absolute yields near 5.68% continue to provide a natural clearing mechanism and attract demand from crossover investors. We view the current backdrop as a potential opportunity to take advantage of elevated yields at attractive valuations.

The Bloomberg Municipal Taxable Index returned +1.19% with spreads at 55 bps.

Investment grade corporates

A tumultuous week saw spreads widen amid rising volatility and sector dispersion, as stress in technology, media and telecom (TMT) pushed those credits notably wider than the broader market. The move was concentrated in AI-linked credits rather than broad-based deterioration. Generic cash widened only modestly while TMT sectors underperformed sharply on growing wariness around heavy AI infrastructure capex and its financing needs. The hotter inflation print prompted several issuers to postpone deal launches, and fund inflows slowed sharply below the four-week average.

The Bloomberg U.S. Corporate Bond Index returned +0.86% with spreads at 84 bps.

U.S. high yield corporates

High yield endured a volatile, bifurcated week driven by stress in data center and AI-adjacent credits. Quality decompression set the tone early, as higher-rated paper traded firm while lower-quality credits sold off meaningfully – a split that persisted through midweek. Thursday brought the most extreme volatility, with bid-ask spreads widening materially and dealers reluctant to make markets, before a late reversal left the market in a fatigued, low-volume tone. Primary issuance was muted.

The Bloomberg High Yield 2% Issuer Capped Index returned -0.33% with spreads at 331 bps.

Preferred securities

Bank preferreds were unchanged while hybrids and Additional Tier 1 (AT1) bonds closed higher, with flows skewed toward better buying driven by fast money and dealer short covering. French risk stabilized after several weeks of volatility, and short-call securities remained firmly bid. The standout development was an idiosyncratic situation in a single hybrid credit, where a pricing strategy overhaul following weak product sales sparked investor concern around potential coupon deferral. There was no new hybrid issuance, as most issuers remain in blackout.

The ICE Preferred Index returned +0.21% with spreads at 182 bps.

Senior loans

Loans contended with a choppy, bifurcated week mirroring the dispersion in high yield, with data center names the most actively traded and volatile corner of the market. The week opened soft and deteriorated further at midweek as lower-quality, beta-sensitive paper sold off meaningfully. Thursday’s stress intensified before reversing sharply in the afternoon, with performing discount paper catching a bid; there was little evidence of forced selling from traditional loan investors. Fund flows were positive and new issue volume reached $3.9 billion.

The S&P Leveraged Loan Index returned -0.13% with spreads at 503 bps.

Securitized credit

Rates rallied despite heightened inflation concerns, though October’s heavy issuance calendar brought softer deal execution across benchmark and esoteric transactions, with issuers of fixed-maturity (time tranche) structures having to widen pricing from initial talk to clear the market. Capital markets remain open, and the market saw a much-needed break ahead of a major industry conference. CLO technicals kept top-tier paper well bid, though a pickup in new CLO deals that refinance older ones has begun weighing on spreads, and secondary selling of AAAs and lower-tier mezzanine widened spreads further. CMBS secondary flows slowed as buyers snapped an eight-week selling streak, though spreads still leaked wider and the credit curve continued to steepen.

The Bloomberg MBS Index returned +0.89% with spreads at 41 bps. The Bloomberg CMBS Index returned +0.51% with spreads at 71 bps. The Bloomberg ABS Index returned +0.33% with spreads at 48 bps.

Global emerging markets

EM hard currency sovereigns gave back some of the prior week’s spread compression, with investment grade unchanged and high yield modestly wider, though several frontier credits outperformed despite lagging the move in rates. Corporates also decompressed, while local markets delivered solid gains on strength in Central and Eastern Europe. Retail outflows accelerated substantially, with hard currency funds and ETFs both seeing meaningful redemptions, partially offset by continued ex-China inflows. New issue supply continued to grind slowly, though demand was stronger than in recent weeks and new deals generally traded around reoffer.

The Bloomberg Global EM Index returned +0.65% with spreads at 180 bps.

U.S. Treasury market yields

Fixed income characteristics and returns