Credit sectors lead markets despite rising geopolitical tensions

Weekly fixed income update highlights

• Treasuries, investment grade and high yield corporates, MBS, preferreds, senior loans and emerging markets all gained.
• Municipal bond yields declined. New issue supply was undersized at $6.9B, and fund inflows were $110M. This week’s new issuance heats up again at $12.5B.

U.S. Treasury yields declined modestly following the U.S. Federal Reserve’s decision to hold rates steady and signal future cuts, while credit markets posted positive returns amid heightened conflict in the Middle East.

Watchlist

• Treasury yields moved lower, and we continue to expect elevated volatility, a wider trading band and a modest rally from current levels.
• Spread sectors benefited from the move lower in rates and generally outperformed Treasuries.
• We expect the technical environment for municipal bonds to improve as the year progresses.

Investment views

We believe fixed income yields generally present one of the best entry points in a generation, creating attractive income opportunities.

Downside economic risks are material, despite strong fundamentals, with tariffs likely to compress consumer spending and weigh on business fixed investment. 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.

Preferred securities show strong performance in June

U.S. Treasury yields declined slightly last week, with the 10-year yield falling -2 basis points (bps) to 4.38%. 2-year yields moved lower by -4 bps. Geopolitical tensions remained in focus, which broadened over the weekend with the U.S. strike on Iran. We expect market volatility to remain elevated and upward pressure on oil prices to persist. Separately, the Fed kept interest rates unchanged, as expected, and continued to signal two cuts are likely later this year. That was slightly more dovish than expected, driving some of the decline in short-term yields.

Investment grade corporates gained, returning 0.28% for the week and outperforming similar-duration Treasuries by 6 bps. The asset class benefited from the move lower in rates, with spreads remaining flat at their recent tight levels around 85 bps. That is still wider than the February lows, but almost 35 bps tighter than their early April peak. Inflows slowed again to $2.3 billion. New issuance was somewhat light and continued to meet with strong demand. Supply totaled $16.25 billion, averaging oversubscription rates of 5x and resulting in concessions of just 0.5 bps. Separately, preferred securities had another strong week, returning 0.44% and outperforming similar-duration Treasuries by 22 bps. Preferreds have been the best-performing major fixed income asset class so far in June, with a total return of 1.00%.

High yield corporates also advanced, returning 0.29% and beating similar-duration Treasuries by 11 bps. Senior loans returned 0.16%, their 11th straight weekly gain. In both asset classes, lower-rated segments generally outperformed, with CCC rated high yield leading the way with a 0.70% return. Inflows were steady, totaling $356 and $291 million into high yield and loans, respectively. Supply was also relatively active, with $6.1 billion pricing in high yield and almost $11 billion in loans.

Emerging markets were more mixed, returning 0.12% but lagging similar-duration Treasuries by -10 bps. Spreads generally widened by around 1 bp across both high grade and high yield spaces. However, inflows accelerated, with $1.1 billion entering the asset class. Issuance was also steady at $9.2 billion, split nearly evenly between corporate and sovereign spaces.

Municipal yields drop amid positive fund flows

Municipal bond yields declined last week, with short-term maturities dropping -3 bps while long-end yields held steady. The reduced new issue market provided traders an opportunity to sell existing inventory from previous weeks. Market sentiment remained positive, evidenced by fund flows staying positive for the eighth consecutive week, including $508 million in exchange-traded inflows. New issuance is expected to increase this week, with deals likely to be well-received.

The municipal market remains resilient, though it lagged Treasuries last week. This underperformance is reasonable given the significant inventory overhang despite last week’s lighter calendar. Looking ahead, new issuance is set to increase again, supported by robust summer reinvestment funds of $140 billion. Taxexempt municipals continue to offer compelling value.

Great Lakes Water Authority, Michigan, issued $529 million in water supply system revenue bonds (rated Aa3/AA). The offering was well received, and some bonds traded at a premium in the secondary market. For example, 5.25% coupon bonds maturing in 2050 were initially priced at a 4.81% yield and subsequently traded at 4.80% in the secondary market.

High yield municipal bond market supply and demand dynamics were affected by the U.S. holiday-shortened week. Inflows moderated significantly at just $58 million. New issuance deals were concentrated in the first three days of the week, creating a challenging environment for some deals to gain full market attention. Looking forward, the new issue pipeline is expected to maintain a moderate pace. High yield municipal indices remain stable, averaging around 5.83%, with numerous opportunities available at even more attractive yields.

Senior loans saw their 11th straight weekly gain, with lower-rated segments generally outperforming.

In focus: The Fed offers calm before the cuts

As expected, the Federal Reserve kept rates unchanged last week, with the target fed funds rate range holding at 4.25% to 4.50%, but signaled that easier policy lies ahead.

The central bank made few substantive changes to its policy statement. Language stating that “uncertainty about the economic outlook has increased further” was removed in favor of a more moderate comment that uncertainty “has diminished but remains elevated.”

The Fed updated its economic projections, lowering its 2025 GDP growth forecast to 1.4% (from 1.7% in March) and anticipating core inflation will edge up to 3.1% (from 2.8%) by year-end. Those changes reflect the expected impact of large tariffs, which will likely hinder growth and push up prices. According to the Fed’s closely watched dot plot, policymakers still expect two 25 basis point (bps) rate cuts in 2025.

In his press conference, Chair Powell emphasized that conditions are still “highly uncertain” and that “the appropriate thing to do is hold where we are” even as the Fed believes consumer prices will rise, reflecting the impact of tariffs. We anticipate two 25 bps rate reductions this year, followed by a few more in 2026. These forecasts are based on our macroeconomic outlook and a probability-weighted view on the outlook for tariffs. But if the levies end up steeper than our models suggest, the Fed could loosen policy more aggressively (and vice versa).