Fixed Income

Chasing Duration Has Been a Fleeting Strategy

So, where can Treasury (UST) yields go in this environment? The age-old question in fixed income is: when should I go long duration? Over the last two years, this has been an ongoing query for investors, and more recently, with the Fed’s recent rate cuts, it has come back on the front burner, for sure.

Trading activity in the U.S. Treasury (UST) market has been rather volatile over the last two years, with large absolute yield level movements occurring (roughly 100-bp swings from highs and lows) against the backdrop of a broader “sawtooth” pattern.

Going “long duration” inherently means you believe the economy is headed toward a recession with no inflationary pressures, and the UST 10-Year yield is going to decline to the 2024 low of 3.60%, at a minimum. However, an economic backdrop of moderate growth and no meaningful upward price pressures puts the UST 10-Year yield in a fair-trading range of 4%–4.50%.

Although the Treasury yield curve has “un-inverted,” it remains historically flat. Following the Fed’s most recent 25-bp rate cut, the spread between the new Fed Funds mid-point and the UST 10-Year yield is roughly +50 bps. The long-run average for the Fed Funds/UST 10-Year spread is about +130 bps, or a hefty 80 bps above its current level.

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 “going long duration” trade.

Saying Goodbye to 2025, Embracing 2026

It has been a strong year for fixed income. Interest rates moved lower, with the 10‑Year Treasury yield on track to post its first annual decline in five years. Credit spreads have narrowed and are now tighter on the year, fully reversing the pre‑Liberation Day anxiety that weighed on corporate bond markets in the first quarter. Income, duration and credit have all contributed positively in 2025.

The Bloomberg Aggregate Index is up 7.03% year-to-date, marking its best annual result in five years and placing 2025 in roughly the top quartile of bond market returns so far this century. Emerging market local debt, as measured by the JP Morgan GBI‑EM Global Diversified Index, has returned 17.24% year-to-date, its strongest performance since 2009. Even municipal bonds, which came under pressure during the fiscal debate in the first four months of the year, rebounded sharply and went on to deliver some of the highest returns among U.S. fixed income sectors in the second half.

During the fourth quarter, returns remained positive but slowed noticeably. Treasury note yields were confined to a narrow range, and an early widening in high-yield credit spreads, following the “cockroach” comments, quickly reversed. Market behavior resembled a good party winding down: the energy faded, the refreshments ran out (i.e., the new data dried up), and most participants wrapped up the year feeling satisfied while turning their attention to what comes next.

Looking at valuations compared with a year ago, yields are lower, the curve has steepened, and credit remains fully valued. Our economic outlook is broadly consistent with last year’s, though with the prospect of less support from the Federal Reserve and more moderate labor-market growth. As a result, income is expected to be the primary driver of fixed income performance. With lower starting yields, expectations for overall returns should be somewhat tempered heading into 2026: still positive, but likely more modest, supporting a steady allocation to fixed income.

We maintain a neutral stance on duration, with selective over-weight positions in securitized debt and corporate credit, focused on higher-quality issuers.

Income Remains the Focus

Securing diversified sources of income remains a key priority. Within U.S. taxable markets, securitized debt continues to be our preferred avenue. We expect the rally in agency residential mortgage-backed securities to continue and to broaden into other areas of the securitized market, as deregulation and freed-up bank capital help drive stronger demand from banks.

In corporate bonds, we recognize that current valuations leave less room for missteps, but fundamentals still provide support for today’s yield levels. Careful selection and discipline are essential. In both high-yield and investment-grade markets, we favor issuers with stronger balance sheets and more resilient business profiles. Within investment-grade, we are watching the recent wave of issuance tied to artificial intelligence and assessing its potential impact on spreads. In high yield, we continue to prefer low-duration bonds over senior loans, given their broader sector diversification.

Outside the U.S., emerging market local debt continues to offer appealing income opportunities, supported by a geopolitical landscape that is less disruptive than last year and by improving inflation trends in many countries. While the boost from a weakening U.S. dollar has diminished, we still see value in the higher-yielding bond markets across Latin America.

Despite the strong rebound in municipal bonds during the second half of 2025, we continue to see meaningful value in the sector for tax-aware portfolios. Yields remain appealing, both in absolute terms and relative to taxable alternatives, and credit quality remains solid. Strong coupon reinvestment in January should also provide additional technical support.

Within the municipal market, we favor revenue-backed sectors, such as public utilities and water and sewer systems, over lower-yielding general obligation bonds.