Fixed Income

Chasing Duration Continues to be a Fleeting Strategy

The Middle East war has proven to be a bit of a conundrum for the Treasury (UST) market. Typically, in times of geopolitical uncertainty, Treasuries are viewed as a safe-haven asset to turn to. While Treasury Floating Rate Notes (FRNs) have seen flight-to-quality flows, the fixed coupon maturities have not. In fact, other than the FRN space, there has been no place to hide along the UST yield curve, as short, intermediate and longer-dated maturities have all seen yield levels rise in a visible fashion.

While the surge in energy prices has stoked inflation fears, other factors contributing to the sell-off have been reversing prior ‘long’ and yield curve positioning, as well as potential liquidation by Persian Gulf nations to raise cash to pay for infrastructure repairs that have been damaged by Iranian missiles and drones.

When the war in the Middle East shows signs of de-escalating, or actually ends, our thesis for Treasuries remains one where yield levels will continue to reside at their elevated historical readings. For those who continue to want to go “long duration” that inherently means you believe the economy is headed toward a recession with no inflationary pressures, and that the UST 10-Year yield is going to decline towards the 2024 low of 3.60%, at a minimum. However, our economic backdrop of moderate growth and above ‘Fed target’ inflation puts the UST 10-Year yield in a fair-trading range of 4%–4.50%.

Against this backdrop and given the track record for long duration over the last two-year period, as well as our macro-outlook and relative value analysis, we would recommend holding off on the “long duration” trade, and see the path of least resistance for the Treasury yield curve as being more than likely to steepen in 2026.

Fixed Income Allocation: Positioned for Resilience, Prepared for Change

Over the last month, the conflict in Iran has evolved from a short-term market shock to one with pervasive impact for global markets and the global economy. The announcement of the two-week ceasefire brings hope, but it is as of now temporary. The conflict has also created economic distortions that will take time to work out. Investors need to remain vigilant in assessing not only their base case expectations but also the range and probability of alternative outcomes.

Our central view remains intact: U.S. growth continues to demonstrate resilience, and inflation expectations, while elevated, remain broadly anchored. However, the distribution of potential outcomes has widened. Both upside and downside scenarios now carry greater risk, increasing the cost of being wrong and raising the bar for high-conviction, off-benchmark positioning.

Current Positioning: Balanced and Intentional

Within fixed income, we remain comfortable with our current positioning, which reflects a deliberate balance between income generation and capital preservation:

• • • Duration: We maintain a neutral duration stance, reflecting uncertainty around the path of interest rates and the timing of potential policy shifts. This positioning allows flexibility without overcommitting to a single rate scenario.
    • Credit Exposure: Our credit allocation remains aligned with an income-oriented approach but is intentionally skewed toward higher-quality issuers.
    • Securitized Assets: We hold a modest overweight to securitized credit, where structural protections and underlying collateral quality continue to offer attractive risk-adjusted returns.
    • Municipal Bonds: Within tax-sensitive accounts, we continue to prefer municipal securities, which continue to provide compelling after-tax income and strong credit fundamentals.

While our base case remains constructive, we are actively evaluating opportunities to adjust positioning on further developments in the geopolitical backdrop. Should the temporary ceasefire evolve into one of more permanence , we would expect risk assets to perform well, accompanied by a potential weakening of the U.S. dollar. In this case, select exposures such as emerging market local debt and gold could offer incremental value. Conversely, if the temporary ceasefire breaks down, risk assets would again become more vulnerable and safe haven investments like U.S. Dollar-Bullish currency strategies could offer resilience amid enhanced market volatility.

While the Iran conflict has dominated daily headlines, concerns about AI vulnerability for industries and the private credit market quickly resurface on slow news days. Recent discussions around artificial intelligence have highlighted potential vulnerabilities across certain industries, especially those heavily reliant on legacy software models. At the same time, segments of the private credit market have come under scrutiny, with isolated cases of fraud and redemption restrictions raising investor concerns.

Our assessment is that risks within private credit remain largely idiosyncratic rather than systemic. However, we recognize a growing disconnect between investor expectations of liquidity and the restrictions inherent in many of the private funds holding these investments. This gap has the potential to drive short-term volatility, particularly during periods of market stress.

As a result, we believe it is prudent for investors to reassess their exposure to areas with elevated sensitivity, including:

• • • Debt linked to software and data center infrastructure
    • Financial institutions with meaningful exposure in lending to private credit markets

We prefer quality-screened high yield debt with lower exposure to the software sector than senior loans, which have often featured much heavier software exposure, and bank-dominated preferred securities, where exposure to financial sector dynamics and potential spillovers from private credit warrants a more measured approach.