Treasury yields decline on easing trade tensions

Weekly fixed income update highlights

• Treasuries, investment grade and high yield corporates, MBS, preferred securities, senior loans and emerging markets all rallied last week.
• Municipal bond yields declined substantially. New issue supply was scheduled to be $11B, and fund outflows were -$1.2B. This week’s new issuance is scheduled to be $13B.

U.S. Treasury yields declined and spreads tightened across fixed income markets as sentiment broadly improved. The extreme volatility triggered by the so-called tariff tantrum earlier this month seems to be calming, at least for now.

Watchlist

• 10-year Treasury yields moved lower, and we continue to expect elevated volatility, a wider trading band and a modest rally from current levels.
• Spread sectors gained versus Treasuries amid signs of tariff policy progress.
• We expect the technical environment for municipal bonds to regain strength as the year progresses.

Investment views

More rate cuts are coming, but not immediately, as the Fed weighs still-strong economic data and the potential for higher inflation against deteriorating sentiment and a worsening medium-term outlook.

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

Risk premiums may widen further, with entry points for taxable fixed income likely to become more attractive over the coming quarters. Credit selection remains key as we search for bonds with favorable income and solid fundamentals.

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 performance improves

U.S. Treasury yields moved lower and market conditions calmed somewhat in the holiday-shortened week. 10-year yields fell -17 basis points (bps) to 4.33%, while 2-year yields fell -16 bps. Measures of implied volatility in the bond and equity markets both fell back from recent highs but remain relatively elevated versus history. Although there were no concrete developments on tariff policy, President Trump said that he “had a very productive call with the President of Mexico,” that “big progress” was made with a negotiating delegation from Japan, and that he expected “a good deal with China.” Separately, U.S. Federal Reserve Chair Powell leaned hawkish in a speech about the economic outlook, saying that “measures of near-term inflation expectations have moved up significantly.” Nevertheless, markets continue to price more than three rate cuts for this year.

Investment grade corporates rebounded, returning 1.22% for the week and beating similar duration Treasuries by 35 bps. Spreads tightened by 5 bps, though they remain around 30 bps wider than their year-to-date tights. Supply picked up substantially, with more than $36 billion pricing and skewed toward the financial sector. Four of the six major U.S. banks issued new debt, and demand remained strong. New issue concessions averaged less than 3 bps by midweek after reaching around 6 to 7 bps the week prior. Overall, investment grade corporate yields are at 5.34%, just 1 bps higher than the start of the year. But that flat overall change masks a 50 bps trading range this year.

High yield corporates also improved, returning 1.26% and outperforming similar-duration Treasuries by 63 bps. Senior loans gained +0.45%. That was the best weekly performance for both asset classes since 2023. Outflows totaled just over -$3 billion split nearly evenly between high yield bonds and senior loans, but the pace slowed substantially from the prior week’s outflows of more than -$16 billion.

Emerging markets outperformed, returning 1.58% and outpacing similar-duration Treasuries by 75 bps. The asset class was substantially helped by the better tone of tariff-related comments from the White House. Emerging markets currencies advanced versus the dollar after three straight weeks of selloffs. That dynamic was supported by a surprise rate hike from the Central Bank of Turkey, which boosted the lira and improved sentiment among investors.

Investors rediscover muni bonds

Municipal bond yields ended last week substantially lower. Short-term yields declined -21 bps and long yields were down -18 bps. It’s unlikely that all of the new issue deals were placed, as the volatile market dampened broad interest for such large supply. While outflows continued overall, exchange-traded funds saw inflows of $659 million. It may be difficult for the market to absorb all of this week’s new issuance.

Heavy supply remains the main driver pushing muni yields higher. But at these yields, individual investors have finally rediscovered the muni market. Individuals can buy intermediate bonds at a 4% tax-exempt yield and long bonds at 5%. And institutions are buying munis even though they don’t need tax-exempt income. Some tax-exempt bonds offer yields equal to taxable long bonds but with a more attractive risk profile. Finally, demand should be boosted by reinvestment money of approximately $35 billion each month for May, June and July.

The state of Oregon issued $624 million general obligation bonds (rated Aa1/AA+). The deal was priced cheaply due to volatile market conditions and was very well received. Bonds were trading at a premium in the secondary market to where they were originally issued.

The high yield municipal market saw large outflows last week. The Bloomberg High Yield Municipal Bond Index breached 6% yield briefly before demand started a normalization. We have tracked a number of attractive new deals that have offered investors more than 7% yield.

Muni bond demand should be boosted by reinvestment money of around $35 billion each month for May, June and July.

In focus: ECB cuts again, prepares to wait

Prior to President Trump’s tariff announcements in early April, market forecasts for another rate cut by the European Central Bank were mixed, as policymakers weighed the effects of fiscal stimulus against trade risks. But uncertainty fueled by U.S. trade policy prompted the ECB to reduce its benchmark deposit rate by 25 basis points, to 2.25%.

The ECB struck a cautious tone, assessing growth risks as tilted to the downside. Easing services inflation, tightening financial conditions and lower oil prices also supported the central bank’s move. In a surprise, the ECB no longer assessed its policy stance as “restrictive,” a hawkish hint for future decisions.

In our view, with the hit to demand likely to materialize before European fiscal stimulus kicks in, policymakers could continue cutting the deposit rate to around 1.75% through Q3 amid a highly uncertain backdrop. In particular, the ambiguity on the outlook for inflation warrants a careful rate cutting stance.

We believe it would require a material downside growth surprise or a collapse in sentiment for the ECB to reduce rates below neutral — the level at which monetary policy is neither accommodative nor restrictive. A further rally by the euro against the dollar also bears watching, as the stronger currency makes European exports less competitive and could hinder growth. All told, the ECB, along with investors, is entering uncharted territory.