Tariff worries send Treasury yields lower

Weekly fixed income update highlights

• Treasuries, taxable munis, investment grade corporates, MBS, CMBS and ABS all rallied.
• Preferreds, high yield corporates, senior loans and emerging markets retreated.
• Municipal bond yields were mixed. New issue supply was $14.2B, and fund inflows were $966M. This week's new issuance is $9.0B.

Fixed income markets diverged last week. President Trump's fresh tariff warnings on China drove U.S. Treasury yields lower and rattled credit markets. High yield corporate spreads reached their widest levels since June, while municipal bonds continued their strong momentum.

Watchlist

• 10-year Treasury yields declined last week, though we expect minimal further declines from here.
• Spread sectors broadly underperformed similar-duration Treasuries amid tariff-driven risk-off sentiment.
• 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.

High yield corporate spreads hit widest levels since June

U.S. Treasury yields fell last week, with 10-year yields ending -9 basis points (bps) lower at 4.03%. 2-year yields fell more modestly, down 7 bps to 3.50%. The entire rally occurred on Friday after President Trump warned of fresh 100% tariffs on China, purportedly to take effect 01 November. He cited China's new export controls for certain raw and processed rare earths and threatened export controls of his own for "critical software." Given that the United States imports around $440 billion of goods annually from China, behind only Mexico in terms of total amount, the fresh tariff threat represents a material upside risk to U.S. inflation and downside risk to GDP growth.

Investment grade corporates rallied, returning 0.11% for the week. However, spreads widened by 6 bps and the asset class underperformed similar-duration Treasuries by -47 bps. Most of the widening occurred on Friday, alongside renewed tariff threats. Inflows slowed slightly but remained healthy at $8.9 billion. Supply was soft again, totaling $13.2 billion, and demand remained healthy with average oversubscription rates of 4x and new issue concessions of just 1.3 bps.

High yield corporates retreated, returning -0.73% and lagging similar-duration Treasuries by -98 bps. Spreads jumped 36 bps wider to 304 bps, their widest levels since June. Senior loans returned -0.30%, their worst weekly performance since the initial trade shock in early April. That snapped a nine-week run of gains. Both asset classes experienced inflows, with $2.1 billion entering high yield funds and $544 million flowing into loans. Supply was steady, with $5 billion and just under $21 billion pricing across high yield and senior loans, respectively.

Emerging markets fell marginally, returning -0.07% and lagging similar-duration Treasuries by 57 bps. Spreads were mixed, with notable outperformance by Argentina, where yields fell more than 100 basis points on dollar-denominated debt after the U.S. announced bilateral support measures. Supply slowed somewhat across the emerging markets asset class, with just under $12 billion pricing. Demand softened slightly, with average oversubscription rates down to 3.2x. However, inflows were strong with $894 million entering the asset class.

Municipal bonds post heavy September inflows

The municipal bond yield curve flattened again last week, with short term yields rising 2 bps and long-term yields declining -4 bps. The new issue calendar was well received. Fund flows were positive, including $860 million into exchange-traded funds. This week's new issue calendar should also be well received.

The muni market remains well bid for several reasons. The Treasury market provides stability. Reinvestment moneys coming in for October. Although new issue supply for October has been outsized, there continues to be solid demand for tax-exempt bonds from individual and institutional investors. In fact, municipal fund flows for September were $7.9 billion, the largest monthly inflow since October 2024. Municipal inflows are now $36.2 billion year-to-date. The muni market should remain well bid for the foreseeable future.

New York City issued $1.5 billion general obligation bonds (rated Aa2/AA). The deal was well received, and underwriters lowered yields on most maturities upon final pricing.

High yield municipal fund flows continued building, firming demand that kept a higher level of new issuance well subscribed and bids strong in the secondary market. High yield muni index yields decreased on average. Nuveen is observing stronger demand expand further toward areas that lagged the recent breakout rally in September.

High yield corporate spreads jumped 36 bps wider to 304 bps, their widest levels since June.

In focus: Municipal market at an inflection point?

Municipal bond returns moved positive for the year in Q3, and we think the market has reached an inflection point. A strong rally has been supported by favorable technicals, robust fundamentals and historically attractive yields. After underperforming broader fixed income markets earlier in the year, municipals staged a rebound, aided by renewed investor inflows.

Key drivers include the U.S. Federal Reserve's shift toward rate cuts and strong state and local credit metrics, with tax revenues and reserves remaining elevated. Additionally, a historically steep municipal yield curve has caught buyer interest as investors seek yield pick-up opportunities in longer maturities. Nuveen believes that 10- to 20-year investment grade municipal bonds may provide compelling opportunities, given favorable relative value versus shorter maturities.

Supply dynamics are shifting. While 2025 issuance has been high, issuance is expected to taper in Q4, easing supply pressure. Meanwhile, demand remains strong, with significant inflows into municipal funds, especially intermediate and long durations.

Overall, we view the current municipal environment as a compelling entry point. With additional Fed rate cuts expected, positive fund flows, credit strength and seasonal supply/demand dynamics, muni bonds appear well positioned for continued gains through the end of 2025 and into 2026.