Credit markets absorb supply despite tech concerns

Weekly fixed income update highlights

• Treasuries, municipals, mortgages, investment grade and high yield corporates and emerging markets advanced last week.
• Senior loans and preferreds retreated.
• Municipal bond yields were essentially unchanged. New issue supply totaled $8.7B, and fund inflows were $2.4B. This week's new issuance is $13B.

Fixed income markets navigated mixed signals last week. U.S. Treasury yields declined modestly and credit markets absorbed heavy supply despite equity volatility. Software sector weakness weighed on performance, though strong investor demand generally persisted.

Watchlist

• 10-year Treasury yields were slightly lower last week, and we expect a modest rally from current levels.
• Spread sectors generally underperformed versus similar-duration Treasuries as the software sector was pressured.
• We believe 2026 presents favorable market dynamics for municipal bonds.

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.

Software sector weakness weighs on credit markets

Treasury yields moved lower last week, with 10-year yields falling -3 basis points to 4.21% and 2-year yields declining -2 bps. Economic data was mixed. Several labor market measures weakened more sharply than expected. Job openings declined to a new post-Covid low, and January layoffs, as measured by a private sector gauge, picked up materially. However, jobless claims remained low and business sentiment improved. Overall, we continue to expect the labor market to stabilize in the near term. Separately, equity markets were volatile as concerns surfaced about AI's impact on software companies' outlooks. Though headline indexes ended nearly flat for the week, the software sector fell almost -8% and is down almost -15% over the last two weeks.

Investment grade corporates advanced, returning 0.26%, though the asset class lagged similar-duration Treasuries by -6 bps. Spreads widened 2-5 bps overall, with the software sector leading the weakness at 10-20 bps. Despite the volatility, inflows picked up substantially to almost $13 billion, the largest weekly inflow since 2020 and the fourth-largest ever. Supply was heavy at just over $60 billion, almost double consensus expectations for the week. Those deals were oversubscribed by an average of 4x, resulting in new issue concessions of 1.6 bps - still narrow versus history but slightly wider than the year-to-date average.

High yield corporates gained, returning 0.11%, but underperforming similar-duration Treasuries by -6 bps. Senior loans weakened -0.24%. The software sector's weakness largely explains the performance difference, as roughly one-quarter of the loan market is software versus less than one-tenth in high yield. Both asset classes enjoyed inflows: $421 million into high yield and $606 million into loans. Supply decelerated in both markets, with $5.2 billion and $3.3 billion pricing across high yield and loans, respectively.

Emerging markets rallied 0.22% but lagged similar-duration Treasuries by 7 bps. Inflows slowed to $1.6 billion but remain relatively elevated. Supply was muted at $6.2 billion, with average oversubscription rates of 3.5x. The dollar reversed course. After providing a tailwind over the prior two weeks, it rallied 0.66% amid the risk-off tone in equities, which weighed on emerging markets performance.

Strong demand and reinvestment flows support munis

The muni market remains well bid, supported by a strong Treasury bond market and demand that continues to outstrip supply. We are in a two-month period of outsized reinvestment flows, with $47 billion set for February 1 and $32 billion for March 1. This should easily absorb the new issue calendar seen so far this year and expected in the near term. We believe the muni market should remain well bid for the foreseeable future. However, new issue municipal supply is expected to reach a record $600 billion this year, producing some weeks of outsized supply. We would view any muni market selloff caused by such oversupply as a potential buying opportunity.

The Chicago Transit Authority issued $533 million in sales tax receipt revenue bonds (rated NR/A+), which were well received. The underwriter is quoting a slight premium to all four max-yield maturities from their original pricing.

High yield municipal fund flows have increased every week this year. Inflows totaled $546 million last week, with 90% going into mutual funds. We think accelerating fund flows and record February reinvestment flows position the market well. Nuveen is tracking 13 new deals totaling $900 million for this week, including BBB rated issues, though true high yield deals represent only $350 million. We expect strong secondary market demand to expand further.

We think accelerating high yield municipal fund flows and record February reinvestment flows position the market well.

In focus: ECB is content to play the waiting game

Last week the European Central Bank held its benchmark interest rate at 2% for the fifth meeting in a row, as ECB President Christine Lagarde again emphasized that inflation is "in a good place."

Her assessment followed generally positive economic news for the eurozone. Headline inflation fell to 1.7% in January — below the ECB's 2% target — core inflation (excludes food and energy prices) dipped to 2.2% and fourth quarter GDP growth registered a slightly better-than-expected 0.3%.

Despite this encouraging backdrop, Lagarde acknowledged a "still uncertain" outlook amid a "challenging" trade environment due to tariffs and the euro's recent rally versus the U.S. dollar.

The euro's rise hurts the eurozone's manufacturing and export sectors and, while keeping a lid on consumer prices, could fuel disinflation. However, we think this currency strength becomes problematic only if it proves persistent enough to feed into domestically driven inflation. That hasn't happened yet, and the region's inflation expectations remain anchored.

Meanwhile, the ECB is still firmly in pause mode. Germany's fiscal stimulus should boost growth modestly later this year, potentially lifting inflation and enabling the ECB to stay patient. And although traders have priced in a slim chance (about 20%) of a quarter-point rate cut this year, we think a modest tightening cycle may begin in late Q4 or early 2027.