Treasury curve flattens as the Fed shifts its tone

Key takeaways

• Chair Warsh's first Fed meeting delivered a hawkish surprise — no 2026 cuts projected and the easing bias removed.
• The yield curve bear-flattened, reflecting diverging inflation and growth concerns following the Fed's shift.
• Fixed income returns were broadly positive, with declining oil prices and a tentative U.S./Iran agreement offsetting the hawkish policy shift.

Market recap

Chair Warsh’s first meeting as U.S. Federal Reserve chair set the tone for the week, delivering an incrementally hawkish shift that reshaped near-term rate expectations. The dot plot forecast was revised to show no cuts in 2026 and the easing bias was removed from the policy statement. Warsh declined to share his own rate views and announced five task forces to examine the Fed’s communications, balance sheet, data sources, productivity and inflation frameworks. The yield curve bear-flattened sharply — short rates rose while the long end rallied as growth concerns resurfaced. Oil prices continued to decline following a tentative U.S./Iran peace agreement.

Despite the policy shift, fixed income returns were modestly positive. The Bloomberg U.S. Aggregate Bond Index returned +0.15%, investment grade corporates +0.15%, preferreds +0.33%, high yield corporates +0.10%, emerging markets +0.32%, senior loans +0.21% and MBS +0.09%.

Outlook

Chair Warsh’s hawkish pivot confirms our view for no rate changes in 2026. The revised dot plot aligns with our forecast, and we continue to see the next move as a cut — but not until H1 2027. We expect the year-end 10-year Treasury yield to hold close to a 4.25% to 4.50% range.

Three factors support the Fed’s cautious stance. The oil futures curve prices $85 per barrel through year-end, keeping energy costs elevated. Tech-related measurement distortions continue inflating core CPI. And payroll growth has reaccelerated, averaging roughly 190,000 jobs per month over the past three months. Looking ahead, we expect inflation to ease slightly in 2027 as year-over-year comparisons become easier. Combined with gradual labor market softening, this should give the Fed room to resume cutting toward its estimated neutral rate of 3.00% to 3.25%.

Weekly fixed income snapshot

U.S. Treasuries

The curve bear-flattened as the Fed delivered a hawkish shift at Chair Warsh’s first meeting. The dot plot forecast was revised to show no cuts in 2026, the easing bias was removed from the policy statement and Warsh declined to offer his own rate views. He announced five task forces to review Fed processes, with recommendations expected by year-end. Short rates rose as near-term expectations repriced higher while the long end rallied modestly on growth concerns. Current yield levels remain well above their 10- and 20-year historical averages.

The 2-year Treasury yield rose 10 bps to 4.18%, the 5-year rose 3 bps to 4.23%, the 10-year fell 3 bps to 4.46%, the 20-year fell 6 bps to 4.91% and the 30-year fell 7 bps to 4.90%.

Tax-exempt municipals

Tax-exempt municipals outperformed Treasuries, largely shrugging off the hawkish Fed outcome. Muni 2- and 10-year yields fell 2 to 3 basis points (bps) even as short-term Treasury rates spiked. Supply of $11.1 billion was easily absorbed, with longer maturities drawing robust demand. Fund flows added another $1.2 billion, with high yield strategies recording their best week of the year as investors reached for income. Tax-exempt demand remains in focus as wealth tax proposals advance — Rhode Island enacted a surtax on income over $1 million and California’s proposed billionaire’s tax appears headed to the November ballot.

The Bloomberg Municipal Index returned +0.37%.

Taxable municipals

Taxable municipals posted a solid gain, benefiting from the rally in long-end Treasuries and steady demand from crossover investors. The sector’s longer duration profile was a tailwind, as 20- and 30-year yields declined. Performance remains strong year-to-date, and the sector’s yield advantage over comparably rated corporates continues to attract buyers.

The Bloomberg Municipal Taxable Index returned +0.34% with spreads at 51 bps.

Investment grade corporates

Investment grade corporates posted a modest gain as spreads widened just 1 bp to 73 bps — a resilient outcome given the hawkish Fed pivot. Technicals remained constructive, with continued fund inflows, well-absorbed new issuance and subdued credit volatility. Declining oil prices and the tentative U.S./Iran peace deal provided an offsetting tailwind. All-in yields above 5% continue to attract a broad buyer base, and corporate fundamentals remain supportive.

The Bloomberg U.S. Corporate Bond Index returned +0.15% with spreads at 73 bps.

U.S. high yield corporates

High yield posted a modest gain as spreads held steady, with the market balancing the hawkish Fed shift against improved geopolitical sentiment from the U.S./Iran deal. The sector’s short duration profile limited the impact of rising front-end rates, and demand for income remained steady. Technicals remain supportive, with manageable supply and well-contained default expectations.

The Bloomberg High Yield 2% Issuer Capped Index returned +0.10% with spreads at 265 bps.

Preferred securities

Preferred securities posted a solid gain, driven by the rally in long-end rates. Although spreads remained under pressure from recent heavy supply, the favorable rate move more than offset wider credit. Demand from income-oriented investors held steady, and the sector continues to offer an attractive yield profile relative to other fixed income alternatives.

The ICE BofA U.S. All Capital Securities Index returned +0.33% with spreads at 149 bps.

Senior loans

Senior loans posted a positive return, continuing to benefit from their floating-rate structure as short-term rates moved higher. The asset class remains attractive for investors seeking high current income with minimal duration risk. Technicals are supportive, with steady collateralized loan obligation (CLO) demand and manageable supply.

The S&P Leveraged Loan Index returned +0.21% with spreads at 489 bps.

Securitized credit

Securitized sectors were mixed. Agency MBS gained modestly as the long end rallied, though spreads widened slightly. ABS was roughly flat as risk appetite held steady despite the hawkish Fed tone. CMBS declined modestly as spreads drifted wider. The securitized complex remains well-supported by structural protections and steady demand.

The Bloomberg U.S. Mortgage-Backed Securities Index returned +0.09% with spreads at 24 bps. The Bloomberg CMBS ERISA-Eligible Index returned -0.02% with spreads at 65 bps. The Bloomberg Asset-Backed Securities Index returned -0.02% with spreads at 45 bps.

Global emerging markets

Emerging markets debt posted a positive return as the tentative U.S./Iran peace deal and declining oil prices lifted sentiment. Hard currency sovereigns saw continued spread tightening and local markets benefited from the improving geopolitical backdrop. A stronger dollar weighed modestly but overall flows remained constructive.

The Bloomberg Global Aggregate Unhedged Index returned +0.32% with spreads at 157 bps.

U.S. Treasury market yields

Fixed income characteristics and returns