Strong technicals drive outperformance

Weekly fixed income update highlights

• Treasuries, mortgages, taxable municipals and investment grade corporates retreated.
• Preferreds, high yield corporates, senior loans and emerging markets had positive total returns.
• Municipal bond yields were mixed. New issue supply was $11.4B, and fund inflows were $1.8B. This week's new issuance is $11.4B.

Fixed income markets showed resilience last week despite mixed signals. Treasury yields rose on inflation concerns while credit spreads tightened across investment grade, high yield and emerging markets. Municipal bonds outperformed as strong technicals and substantial reinvestment flows supported demand across the curve.

Watchlist

• 10-year Treasury yields rose last week, and we expect a modest rally from current levels.
• Spread sectors generally outperformed versus similar-duration Treasuries amid positive economic data.
• 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.

Strong technicals support corporate fixed income

U.S. Treasury yields rose last week despite superficially softer inflation data. 10-year yields climbed 6 basis points (bps) to 4.22%. Core consumer prices increased just 0.2% in December, holding the year-over-year rate at 2.6%. However, these figures continue to be distorted by data disruptions from the government shutdown. Core PCE inflation - the Fed's preferred measure - is likely to show an acceleration toward 3% when year-end data are released next month. Meanwhile, November retail sales were strong at around 5% year-over-year, signaling continued consumer resilience.

Investment grade corporates returned -0.01% but outperformed similar-duration Treasuries by 18 bps as spreads tightened. Despite new issuance exceeding $54 billion, the technical backdrop remains supportive. Deals were well received, with oversubscription rates averaging 5x, and new issue concessions of less than 1 bp - down from last week's ~2 bps and 2025's ~3 bps. Inflows accelerated to $10.3 billion.

High yield corporates advanced, returning 0.17% and outpacing similar-duration Treasuries by 27 bps. Senior loans returned 0.09%. High yield issuance totaled just $2.7 billion - 60% below expectations - while senior loan issuance exceeded $35 billion. High yield funds saw modest inflows of $25 million; senior loan funds attracted $752 million.

Emerging markets performed well, returning 0.09% and beating similar-duration Treasuries by 28 bps. Despite new geopolitical risks concerning Greenland and Iran, plus ongoing concerns in Ukraine, the asset class remained steady. Inflows accelerated to $1.2 billion. Supply approached $26 billion, with deals averaging 3.5x oversubscription.

A reinvestment wave boosts demand for muni bonds

Municipal bond yields outperformed Treasuries last week, with short-term muni yields declining -7 bps while long munis remained unchanged. New issuance was well received. Long-term funds recorded $1.2 billion in exchange-traded fund inflows, while tax-exempt money market funds saw -$3.4 billion in outflows, suggesting investors are extending duration along the muni curve. Despite this week's U.S. holiday, the new issue calendar should remain robust.

The municipal market remains strong. January's outsized reinvestment money is followed by $47 billion in February and $32 billion in March - unusually large for this period but expected to be readily absorbed. The new issue calendar should build and be well received. We expect munis to remain well bid in the near term.

New York City Transit Financial Authority issued $1.5 billion tax-secured subordinate bonds (rated Aa1/AAA). Strong demand led underwriters to lower yields across maturities at final pricing.

High yield municipal fund flows continued building, with $346 million in net flows last week. Including reinvestment flows, high yield muni funds attracted an estimated $664 million last week and more than $1 billion year-to-date. Fund managers are balancing the desire to wait for new issuance against the need deploy expanding cash balances. High yield muni yields were flat on average last week, though demand strengthened for current issues like Puerto Rico, tobacco and major toll-road bonds. Managers also found success with bid-wanted lists containing standalone non-rated credits. Nuveen's team observed many charter school and senior living bonds trading at yields well through current valuations. As high yield muni fund cash balances expand, secondary market competition should intensify.

January's outsized muni reinvestment money is followed by $47 billion in February and $32 billion in March.

In focus: Loan investors needn't fear the Fed or market volatility

Although senior loans are directly affected by U.S. Federal Reserve policy, some investors believe - incorrectly — that the asset class can't perform well during periods of Fed easing and falling yields.

Since 1997, loans have posted gains in nine of the 10 years when the Fed lowered rates. The only down year was 2008, when the global financial crisis drove all risk assets lower. We forecast two rate cuts this year, in line with market expectations. Lower rates should spur a rise in M&A activity and benefit otherwise solid businesses that have faced challenges amid higher borrowing costs. Meanwhile, higher-quality loans offer all-in yields of about 6.5%, an attractive outcome on both an absolute and relative basis.

We believe investors seeking to allocate to loans would be best served by active management. To illustrate, since 2021 - as rates have risen, potentially exposing over-leveraged companies — Nuveen's Leveraged Finance Credit Team has avoided most of the issuers that have gone through Liability Management Exercises, or distressed exchanges, while avoiding traditional defaults. Disciplined credit underwriting, a highly selective approach and active management are critical to avoiding credits experiencing negative price action while also identifying discounted loans of issuers whose fundamentals are improving, capturing significant additional income and total return potential.