Fed caution pushes Treasury yields lower

Weekly fixed income update highlights

• Treasuries, MBS, investment grade and high yield corporates, taxable munis, preferreds, senior loans and emerging markets all had positive returns.
• Municipal bond yields remained essentially unchanged. New issue supply was outsized at $11B, and fund outflows were -$216M. This week’s new issuance is manageable at $9.9B.

U.S. Treasury yields declined last week, as the U.S. Federal Reserve held rates steady. The central bank highlighted economic uncertainty and acknowledged inflation risks from proposed tariffs.

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Watchlist

• 10-year Treasury yields declined, but we expect yields to remain range bound during 2025.
• Spread sectors generally outperformed Treasuries, amid positive economic data.
• We expect the technical environment for municipal bonds to remain strong this year.

Investment views

Rates are set to stay higher for longer, as the Fed approaches rate cuts cautiously.

The underlying growth outlook remains healthy thanks to strong consumer balance sheets and solid levels of business investment. This combination should keep corporate defaults low.

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

• Inflation fails to continue moderating as expected, weighing on asset prices.
• Policymakers unsuccessfully juggle fighting inflation with supporting economies still struggling to gain traction.
• Geopolitical flare-ups intensify around the world.

Muted investment grade corporate supply meets strong demand

U.S. Treasury yields moved lower, with the 10- year yield ending the week down 7 basis points (bps) to 4.25%. Front-end yields moved by a similar magnitude. The FOMC meeting on Wednesday was slightly dovish, with an upgrade to the median inflation forecast but no parallel move higher in the policy interest rate outlook. Economic data was mostly healthy, with core retail sales rising 1.0% in February, and 4.4% year-over-year. Industrial production also expanded, running at 1.4% near its fastest pace since early 2023.

Investment grade corporates advanced, returning 0.63% for the week. The asset class outperformed similar-duration Treasuries by 3 bps. Spreads tightened slightly, by 3 bps, to 90 bps. Inflows picked up, at $4 billion for the week, though that level remains below the pace seen earlier this year. Meanwhile, supply was somewhat muted at $36 billion. Those deals were met with continued robust demand, with oversubscription rates of 4x on average, leading to new issue concessions of 3.4 bps. That was the below the year-to-date average concession rate for the first time in two weeks.

High yield corporates also gained, returning 0.43%, though the asset class lagged similar-duration Treasuries by 17 bps. Under the surface, lower-rated segments outperformed, with CCCs outperforming BBs for the first time since early February. Senior loans returned 0.10%. While high yield funds enjoyed inflows of $1.1 billion, loan funds saw outflows of -$1.6 billion. Both asset classes saw modest new issuance, with $3.8 and $3.9 billion pricing across high yield and senior loan markets, respectively.

Emerging markets saw gains, returning 0.31% and beating similar-duration Treasuries by 30 bps. Spreads tightened across the board for both investment grade and high yield sovereigns. Turkey was a notable exception, where 10-year USD yields rose 36 bps after political uncertainty picked up. For emerging markets overall, outflows totaled -$1.1 billion, while supply was muted at $5 billion.

Municipal bond issuance appears more manageable

The municipal bond yield curve was basically unchanged last week, although the 30-year yield ended -5 bps lower. New issue supply was outsized once again. Dealers struggled to get deals fully placed, and balances remain. Fund outflows continued the second week in a row. This week’s new issue supply is manageable and should be well received.

The municipal market has a relatively good tone. This is mainly because Treasuries are well bid, and munis typically trade parallel to the government curve. While muni supply has been outsized so far this year, this week should be manageable. Dealers will have a chance to also sell unsold balances from the previous two weeks. Although fund flows have been negative for the last two weeks, muni yields are at their cheapest levels in two years. This should continue to pique investor interest.

New York Dormitory Authority (State Of New York) issued competitively $2 billion state personal income tax revenue bonds (rated A1/NR). The deal was well received.

High yield municipal bond inflows reaccelerated last week at $314 million, taking the year-to-date total to $5.6 billion. Credit spreads continue to compress due to strong demand. The average yield of the Bloomberg High Yield Municipal Index decreased -7 bps to 5.54%, compared to only a -2 bps decrease for long term AAA munis. New issue deals remain heavily oversubscribed, and the ability to monitor and review a higher number of deals is proving to be a meaningful advantage.

High yield municipal credit spreads continue to compress due to strong demand.

In focus: The Fed holds the line, remains cautious

Last week, the Federal Reserve kept its target policy rate range at 4.25%- 4.50%, as expected, while significantly changing its 2025 outlook for growth and inflation from December.

In its updated Summary of Economic Projections, the Fed lowered its forecast for annual GDP growth from 2.1% to 1.7% while raising its expectations for core inflation (excluding food and energy) from 2.5% to 2.8% by year end, further above its 2% target. The unemployment forecast edged up to 4.4%.

These changes mark the challenging economic backdrop facing Chair Jerome Powell. Weaker growth and unemployment argue for lower rates, while higher inflation calls for tighter policy and higher rates. But in a slightly dovish stance, the central bank continues to expect two rate cuts in 2025.

In his press conference, Powell noted that “clearly some of it, a good part” of the Fed’s hotter inflation outlook was due to President Trump’s tariffs. Powell also emphasized that amid elevated economic uncertainty, “We do not need to be in a hurry to adjust our policy stance.” He noted, but downplayed, the recent deterioration in consumer sentiment and spike in inflation expectations.

We still anticipate a slow, steady pace of rate cuts over the coming quarters, leaving interest rates higher for longer. In such an environment, we favor senior loans, collateralized loan obligations and select commercial mortgage-backed securities.