Treasury yields climb as global headwinds loom

Weekly fixed income update highlights

• Treasuries, MBS, investment grade and high yield corporates, taxable munis, preferreds, senior loans and emerging markets all had negative returns.
• ABS, investment grade corporates and emerging markets outperformed similar-duration Treasuries.
• Municipal bond yields ended the week higher. New issue supply was outsized at $15B, and fund inflows were $872M. This week’s new issuance remains robust at $10.5B.

U.S. Treasury yields moved higher last week after a recent rally amid policy uncertainty. A selloff in European government bonds leaked into the U.S. market, putting upward pressure on yields. Separately, tariff uncertainty continued to dominate sentiment.

Watchlist

• 10-year Treasury yields moved higher, and we expect yields to remain range bound during 2025.
• Spread sectors broadly underperformed Treasuries, reflecting continued concerns about the U.S. economic and policy outlook.
• 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.

Emerging markets lead returns versus similar-duration Treasuries

U.S. Treasury yields moved higher last week, with 10-year yields up 9 basis points (bps) to 4.30%. That move came after seven straight weekly rallies, over which time 10-year yields declined -55 bps. 2-year yields rose only 1 bp. The volatile week saw several competing narratives. First, German policymakers amended the country’s debt brake to allow substantially more fiscal deficit spending. 10-year German bund yields rose 43 bps for the week, the largest weekly move since 1990. That selloff in European government bonds leaked into the U.S. market, putting upward pressure on yields. Separately, tariff uncertainty remained salient. Finally, economic data were mostly positive, with the February jobs report showing a healthy pace of job creation, albeit also a further slowdown in the overall labor market.

Investment grade corporates weakened, returning -0.65% for the week, though they outperformed similar-duration Treasuries by 3 bps. Spreads on the index were flat, with most of the performance driven by the volatility in risk-free rates. Inflows continued at a healthy pace at $6.4 billion. On the other hand, supply was elevated at nearly $73 billion, a weekly high so far in 2025. Those deals were oversubscribed by 4x on average. Concessions increased to 5.3 bps, indicating some discrimination by investors.

High yield corporates retreated, returning -0.28% and lagging similar-duration Treasuries by -17 bps. Senior loans returned -0.07%. Lower-rated segments underperformed in both asset classes. For example, CCC rated high yield corporate spreads widened 24 bps, compared to only 5 bps in BB-rated names. New issuance in both high yield and loans was healthy, totaling $8.3 billion and $20 billion, respectively. Inflows favored high yield bonds, with $1.8 billion entering the market, versus only $60 million for loans.

Emerging markets weakened -0.26%, but the asset class led returns against similar-duration Treasuries, outperforming by 30 bps. Spread levels were mixed, with high yield names generally widening, to mirror the dynamic in U.S. corporates whereby lower-rated segments underperformed. Nevertheless, local markets returned 1.28%, helped by a weaker dollar. Markets moved to price in a slightly less extreme tariff outlook after the U.S. walked-back its measures against Canada and Mexico. Inflows continued, totaling $377 million, while supply was muted at only $2.1 billion.

Heavy supply challenges the municipal market

The municipal bond yield curve ended last week higher. Short-term yields rose 2 bps and long-term yields increased 12 bps. New issue supply was outsized, and some balances remained. Fund inflows remained positive for the seventh straight week. Robust new issue supply is making the muni market feel slightly heavy.

Munis followed the Treasury selloff last week and also contended with heavy new issuance. Continuous outsized supply may challenge the municipal market for the foreseeable future. The market remains fundamentally sound, primarily due to increased demand. We believe munis should remain in a trading range as long as inflation remains in check. And selling pressure in the equity market has benefited munis, with investors rebalancing portfolios into fixed income in general and munis in particular.

The state of Wisconsin issued $254 million general obligation bonds (rated Aa1/AA+). Balances remained at the end of the day. In fact, bonds traded cheaper in the secondary market. This trend reflects how the market sold off as the week progressed. For example, 5% coupon bonds due in 2035 came at a yield of 2.95% and traded in the secondary market at 3.05%.

High yield municipal bonds have been less volatilethan other asset classes for investors seeking attractive income and returns. Credit spreads continue to compress. Last week’s net flows totaled $445 million, taking the year-to-date total to $4.1 billion. Overall muni inflows total $9.4 billion, with $3.4 billion going into investment grade exchange-traded funds. More than two-thirds of all investments in active funds have gone into high yield munis, supporting the relative stability and performance. We have observed a growing number of large but fundamentally weaker deals being teased in the market, making credit selection and vigilance increasingly important.

Municipal bond new issue supply remains robust, and the market is feeling slightly heavy as a result.

In focus: German bunds, ECB vie for attention

German chancellor-in-waiting Friedrich Merz’s announcement of a massive fiscal package sparked a bond market rout, with Germany’s 10-year yield surging 30 basis points, to 2.79%, on March 5. The next day, the European Central Bank cut interest rates.

Germany’s pledge to relax its debt brake to enable higher defense spending and create a €500 billion ($540 billion) infrastructure investment fund marks a profound change for Europe’s largest economy, which has contracted for six consecutive quarters. The measures could boost growth after years of underinvestment, more than offsetting any concerns of fiscal sustainability, in our view. Importantly, Germany has substantial capacity to raise its level of borrowing — its debt-to-GDP ratio (about 63%) sits well below that of its European peers. This fiscal stimulus, coupled with new defense funding initiatives by European Union leaders, are welcome developments.

Barring an escalation on the U.S. tariff front that could renew near-term European growth risks, we believe the 10-year yield could hit 3% by mid-year.

Against this backdrop, and with trade uncertainty brewing, the ECB reduced its benchmark deposit rate by 25 basis points, to 2.5%, while continuing to commit to a data-dependent approach to future policy moves. We think the ECB could take a more cautious stance to additional rate cuts, with the deposit rate reaching 2% by year-end, above our previous call for 1.75%.