Treasury curve flattens as a Fed pause is expected

Weekly fixed income update highlights

• Treasuries, taxable municipals, investment grade and high yield corporates, structured products, senior loans and preferreds all advanced.
• Municipal bond yields declined. New issue supply was $12.1B, and fund inflows were $572M. This week’s new issuance is $11.2B.

The U.S. Treasury curve modestly flattened during a quiet week for economic data. With the 01 August U.S. tariff negotiation deadline fast approaching, another series of trade negotiation deals was announced. And the U.S. Federal Reserve meets this week, but the market has essentially priced out any chance of a rate cut.

Watchlist

• Treasury yields experienced modest changes, and we continue to expect elevated volatility, a wider trading band and a modest rally from current levels.
• Spread sectors generally outperformed Treasuries as economic data remained healthy.
• 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.

Senior loans see historic issuance

U.S. Treasury yields moved in a modest fashion in a week that was void of critical economic data releases. The yield curve flattened, as 2- and 5-year Treasuries rose by 5 basis points (bps) and 1 bps, respectively, while the 10-year Treasury yield declined by -3 bps. With the 01 August U.S. tariff negotiation deadline fast approaching, another series of trade negotiation deals was announced. The most prominent deal was reached with Japan. It will impose a 15% tariff on all imports, including automobiles, down from the 25% tariff that would have taken effect on Friday. This week is likely to feature additional trade deals given the looming deadline. The Fed meets this week, but the market has essentially priced out a chance for a rate cut.

Investment grade corporates performed strongly, returning 0.56% for the week and beating similar-duration Treasuries by 13 bps. Although inflows slowed to $3.6 billion, the overall technical backdrop was supportive. Supply experienced a summer slowdown and totaled $22.7B, missing the $25 billion expectation for the week. The lighter level of new issuance was well-received, with oversubscription rates averaging 5x and average concessions of just 1.1 bps, below the year-to-date average of 3.3bps. Issuance is expected to decline further to $10 to 15 billion this week, maintaining a strong technical backdrop.

High yield corporates also rallied, returning 0.35% and outpacing similar-duration Treasuries by 26 bps. Senior loans returned 0.08%. High yield and senior loan funds saw strong inflows of $912 million and $716 million, respectively. $9.9 billion of new supply priced in the high yield market. The loan market experienced a historic week of issuance, at $66 billion. $60 billion launched on Monday alone, making it the second busiest day on record. Repricing activity continues to dominate issuance in the loan market, and we expect this trend to continue.

Emerging markets advanced, returning 0.56% and outperforming similar-duration Treasuries by 21 bps. High yield sovereigns outperformed their investment grade counterparts, as spreads compressed -17 bps compared to -1 bp for investment grade. Spread compression between high yield and investment grade corporates was similar, with compressions of -1bp and -2bps, respectively. Emerging markets funds flipped back to inflows, with $574 million entering the space. New issuance slowed to $1.8 billion, and those deals were oversubscribed by 4x on average.

Muni market strength continues with August reinvestment coming

The municipal market exhibited strength last week, with short-term muni yields decreasing -3 bps and long yields declining -6 bps. New issues were priced attractively, and dealers adjusted pricing as needed to ensure market clearance. Municipal fund flows returned to positive territory, including $525 million from exchange-traded funds. This week brings another large new issue calendar, which the market appears positioned to absorb.

Several factors contribute to the municipal bond market's resilience. Treasury bonds remain in demand, and munis continue receiving reinvestment funds to handle the substantial new supply. On 01 August, $55 billion in reinvestment money will reach investors' accounts, which should sustain strong demand through summer. Municipal bonds continue offering exceptional value, with intermediate tax-exempt bonds yielding around 4.5% and long bonds 5.0%.

New York City Transitional Finance Authority (TFA) issued $1.5 billion future tax-secured bonds (rated Aa1/AAA). The offering was well-received, prompting underwriters to reduce yields on several maturities during final pricing.

High yield municipal bond yields decreased -3 bps on average last week amid market strengthening. Brightline Florida and Brightline West issuances saw price stabilization. Despite modest outflows for the reporting week ending July 23, daily flow data showed positive movement by week's end. The August reinvestment money should provide additional market support.

The senior loan market experienced a historic week of issuance, at $66 billion.

In focus: The ECB is in a good place to pause

As expected, last Thursday the European Central Bank kept its key policy rate at 2%, a few weeks after ECB President Chrstine Lagarde had declared “target reached” in its battle against inflation.

In its policy statement, the ECB again emphasized a “data-dependent, meeting-bymeeting approach” to ensure “that inflation stabilizes at our 2% target in the medium term.”

The eurozone economy has been resilient, with service sector and manufacturing activity expanding at its briskest pace in 11 months in July. Also, a robust labor market, rising real incomes and solid private sector balance sheets continue to support consumption. Yet in her press conference, Lagarde highlighted that the current environment remains uncertain amid the ongoing trade negotiations between the U.S. and European Union.

Nonetheless, by noting that inflation is “at a good place” and growth is “mostly in line with, if not a little better than, our expectations,” Lagarde offered hawkish hints, prompting traders to pare bets on further cuts this year. We expect the ECB to remain on hold for the rest of 2025, with rates ending at 2.0%.

Regarding fixed income positioning, Germany continues to offer attractive yields, with the 10-year bund at 2.72% as of 25 July. In the near term, the U.S. could outperform, as we anticipate the yield on the 10-year note to decline from 4.39% to around 4.25% by year-end.