Treasury yields decline despite hot inflation data

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 rose across the curve. New issue supply was ousized at $12.2B, and fund inflows were $239M. This week’s new issuance is lower at $6.2B.

U.S. Treasury yields declined slightly, notwithstanding higher-than-expected core prices for January. Spreads generally outperformed Treasuries, with spreads moving tighter.

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Watchlist

• 10-year Treasury yields declined last week, and we expect yields to remain rangebound during 2025.
• Spread sectors generally outperformed Treasuries, with spreads moving tighter.
• We expect the technical environment for muncipal bonds to remain strong this year.

Investment views

Rates are set to stay higher for longer, as the Fed approaches the end of the cutting cycle.

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.

Senior loans continue their march higher

U.S. Treasury yields declined further last week, with 10-year yields down -2 basis points (bps) to 4.48% and 2-year yields dropping -3 bps to 4.26%. That rally came despite Wednesday’s hot CPI print, which showed core prices rising 0.4% in January. That increase was substantially larger than expected, pushing the yearover-year rate back up to 3.3%. However, later in the week, PPI was softer than feared, and retail sales also showed a slowdown. Putting it all together, core PCE inflation for January remains on track to slow to 2.6% year-over-year, down -0.2 percentage points from December. Since the U.S. Federal Reserve targets PCE inflation, not CPI inflation, the overall trend remains favorable. We expect one or two rate cuts later this year.

Investment grade corporates rallied, returning 0.35% for the week and outpacing similar-duration Treasuries by 27 bps. The asset class enjoyed the largest week of inflows since mid-November at $8.3 billion. At the same time, new issuance was light, with less than $20 billion pricing compared to expectations for close to $40 billion. Many issuers likely stayed on the sidelines amid the volatility around the inflation data releases and should return to the market this week. Nevertheless, given the mismatch between supply and demand last week, the asset class was supported and spreads tightened 4 bps to return to their narrowest levels of the year. New issuance was 3.8x oversubscribed, and average concessions were -0.6 bps, a sign of robust demand.

High yield corporates also advanced, returning 0.26% for the week and outperforming similar-duration Treasuries by 15 bps. Senior loans continued their recent steady march higher, returning 0.07%. High yield funds had small inflows totaling $19 million, while loan funds added $1.04 billion. That marks six straight weeks of more than $1 billion entering the loan asset class. Meanwhile, new issuance was steady, with $3.3 billion in high yield and $20.8 billion in loans.

Emerging markets gained as well, returning 0.22% for the week and beating similar-duration Treasuries by 13 bps. Outflows continued for the asset class overall, concentrated in local currency funds. That segment recorded a slimmer total return of 0.07%. Hard currency funds actually saw inflows totaling $137 million. As in other markets, supply was more modest, with $8.9 billion pricing across emerging markets. Those deals met healthy demand, averaging oversubscription rates of 4.6x.

Municipal bond yields diverge from Treasuries

The municipal bond curve sold off top to bottom last week, diverging from the Treasury curve. Both short and long muni yields rose 8 bps. Weekly new issue supply was outsized and deals were left with balances at week’s end. Fund flows were positive, despite exchange-traded fund outflows of -$21 million. This week’s new issue supply ls lower, partly due to the Monday holiday in the U.S. The supply should be well received.

Municipal bond yields rose initially due to the hot inflation number, and the market just couldn’t absorb the heavy new issue supply. Look for prices to recover this week and play catch up to the Treasury rally. Also, this week’s undersized new issue supply should allow investors to clean up balances remaining from last week and absorb the small new issue calendar.

Salt River Project Agricultural Improvement and Power District, Arizona, issued $637 million revenue bonds (rated Aa1/AA+). The deal broke to a discount from where the bonds were issued due to the market sell off. For example, 5% coupon bonds due in 2035 came at a yield of 3.11% and traded in the secondary market at 3.13%.

High yield municipal fund flows remained strong and consistent. Rate and policy volatility are not impacting the steady demand for attractive taxable-equivalent yields. New issue supply remains subdued and the pace of credit spread compression continues.

Investment grade corporates enjoyed the largest week of inflows since mid-November at $8.3 billion.

In focus: Our take on tariffs

Although select tariffs have been delayed or dialed back as global partners negotiate with the Trump administration over border protection and acceptance of deportees, the ultimate outcome will depend on whether the tariffs meet U.S. policy objectives such as domestic security and reducing trade deficits.

Regarding Mexico, we believe the country retains enough economic buffers and policy tools to withstand an extended period of economic volatility. Mexico’s central bank has proven to be independent and credible, underpinning the country’s stability and reducing the prospect of an economic downturn. Additionally, the Mexican banking sector is well capitalized, allowing it to withstand economic or geopolitical tensions. Mexican corporate bonds include multinationals with wide geographic footprints that are adaptable to tariff or supply chain disruptions.

As for China, its economy got off to a solid start in January, with robust consumer spending courtesy of the Lunar New Year. A firm Q4 GDP print would decrease the likelihood of additional fiscal stimulus from Beijing. On the tariff front, President Trump may be willing to negotiate a lasting, wide-ranging trade deal. Meanwhile, China could prosper in an environment in which tariffs on certain sectors are unlikely to be raised and Chinese companies are able to make long-term investment decisions in the context of a more enduring framework.