Market Insights

MARKET OUTLOOK / STRATEGY

Second Quarter 2025

Every quarter our Portfolio Management Committee shares insights and research focused on markets, fixed income sectors, and the economy. We prepared our outlooks and debated key themes that resonated as most relevant. A few stood out. First, the importance of time horizon when considering the implications of policy actions. Second, the diversification and foundational strength of the U.S. economy, its resilience and its growth mentality. Third, risks and uncertainty are higher than normal. Fourth, interest rates are attractive.

As fixed income investors, we tend to worry about downside risks, and it is our happy spot. In the current environment, it is easy to default to a risk-off mentality. Our focus on research helps provide context for determining the appropriate risk profile to navigate the storm. Our base case is for the economy to decelerate, and we believe this trend is in motion. But it will take a while for existing actions to be reflected in growth and labor data, and the economy started the year on solid ground. Recession risks are elevated driven by concerns over Executive actions such as tariffs, DOGE, immigration, and war. Many of these policies have longer term implications if fully implemented but are likely to slowly leak into the economy. The bigger concern is a true shock speeds up the impact. In the absence of that, coupon clipping is a reasonable strategy given high yields.

Historically the corporate sector has the highest beta in the investment grade space. As we assess the sector, corporate fundamentals start from a position of strength. Recent earnings have surprised on the upside, whereas forward projections reflect greater uncertainty and some expectations of slowing. EBITDA growth has outpaced corporate debt, and treasurers have generally reduced leverage. Demand for corporate bonds remains strong, while net supply is tapering off. We are mindful that spreads are at the tighter end of their trading range and uncertainty is high. Given our outlook that growth will weaken, but that recession risk will remain low, our expectations are that spreads may widen, but there are offsetting positive factors that will cushion the magnitude.

As fixed income investors, we appreciate the opportunity to invest in bonds during a period where they provide decent coupon income. With the Fed in wait and see mode, yields may remain high for a while. As such, current interest rate levels are attractive, and we find many opportunities to pick up yield relative to Treasuries across sectors and maturities. We maintain our trading range expectation for the 10-year U.S. Treasury yield at 3.50 – 5.00% for 2025.

In our slow growth environment, the spread sectors generally outperform treasuries. We find value in diversification, although we use a more defensive lens in our sector positioning and risk sizing.

Our security selection will be screened through a lens of modest growth and more stress. We are also mindful of industries that may experience greater challenges and use positioning to reflect our analysts’ viewpoints. Our highest convictions given our outlook are overweights to ABS and shorter-maturity corporates as they provide attractive yields and have limited spread volatility.

During periods of uncertainty, a source of comfort can be obtained by leaning into areas that you can control. In the current environment, attractive yields and investment opportunities provide some shelter from the uncontrollable, with a high probability that bonds will pay their coupons and principal when it comes due. We believe good security selection and active management will add value as this period of high uncertainty plays out. If spreads widen, we will use the opportunity to add spread product to the portfolio. Meanwhile we like the additional income that comes with modest over-weights across the various spread sectors while we await future developments.