Fixed Income

Fixed Income: Rates Return to Normalcy but with Volatility

Post-Liberation Day, the Treasury (UST) market had been the beneficiary of the significant risk-off trade, as the 10-Year yield had, at one point, had fallen close to 50 bps, but quickly reversed course completely in a visible unwinding trade.

Even at its recent low-water mark, the UST 10-Year yield had still not discounted a hard landing. In our opinion, such a reflection would look more like 3.50%, at a minimum. Meanwhile, on the other side of the trade, a sustained reversal of the risk-off trade, with no economic downturn lurking, would probably bring the 10-Year yield back above the 4.50% level.

The bottom line is, just like the Fed, the UST market will more than likely be highly data dependent for yield direction as spring turns into summer. In addition, elevated volatility should also remain a key aspect to trading activity in the months ahead. While risk-off had been recently supportive for Treasuries, headlines could shift to a less friendly backdrop later in Q2/Q3, as fiscal policy and budget deficits could come back into focus.

“The bottom line is, just like the Fed, the UST market will more than likely be highly data dependent for yield direction as spring turns into summer.”

Fixed Income: Asset Allocation

Fixed income markets have been particularly volatile in recent days. Treasuries initially rallied on the back of growing concerns around slowing economic growth and a sharp pullback in equities. However, that rally quickly reversed as questions about future demand for Treasuries surfaced, alongside renewed speculation about broader deleveraging across the market.

Corporate credit spreads widened consistently over the period. Coming into the year, both U.S. high-yield and investment-grade bonds were priced at or near historically tight spreads versus Treasuries, leaving little room for upside. Given that backdrop, we took a relatively neutral stance and emphasized quality in our bond selection to help manage risk. Since then, spreads have moved meaningfully wider during the sell-off and now sit above their five-year averages, creating a more attractive entry point going forward.

If our base case plays out —where the economy holds up well despite tariff-related disruptions, sentiment improves with a potential extension of the 2017 tax cuts and uncertainty begins to ease—we may see a compelling opportunity to increase our positioning in corporate bonds. That said, timing will be key. While tariffs have been postponed, they haven’t been resolved, so we’re approaching reentry with patience and discipline.

We continue to favor securitized debt, where we see attractive valuations and the potential for volatility to ease somewhat in the months ahead. It remains our largest over-weight allocation within our income-focused strategy, reflecting both relative value and our view on risk-adjusted returns.

For tax-managed accounts, the recent cheapening in municipal valuations relative to Treasuries and corporate bonds has created more attractive entry points. That said, much like with corporates, patience and flexibility will be important. Heavy issuance so far this year, tax-driven selling and lingering concerns over tax reform have kept municipals under pressure. With those challenges likely to stick around for a while, we believe a gradual, step-by-step approach to adding exposure makes the most sense.

“If our base case plays out… we may see a compelling opportunity to increase our positioning in corporate bonds.”