Market Insights

Second Quarter 2026

“CELEBRATE GOOD TIMES, COME ON” sang two of our vocally gifted colleagues at the close of our 35th anniversary conference in early June. One is a trained tenor and the other a former lead singer of a local group. Their talent and heart brought the house down. As fixed income investors, we are wired to prepare for the worst, but their performance reminded us to embrace the positive.

We enter the second half of the year cautiously optimistic about the economy despite geopolitical and macroeconomic cross currents. On the positive side, improved shipping traffic through the Strait of Hormuz is helping ease inflation pressure, galactic scale AI spending is boosting GDP growth, while labor market data has improved. Fiscal stimulus may provide an additional tailwind. Aggregate consumer spending continues to show resilience, supported by the wealth effect from solid equity returns, stable labor market conditions, and adequate consumer credit availability. At the same time, CEO confidence is improving, corporate profits remain strong, and policy uncertainty is easing.

We draw comfort from the current level of interest rates, which offer an attractive risk/reward profile. Elevated yields provide solid income and additional return potential if inflation moderates and rates decline. Market technicals remain favorable with firm demand for fixed income, as measured by fund inflows, helping anchor spreads for non-treasury sectors at the lower end of their ranges.

Even with this supportive backdrop, risks remain significant. Stubborn inflation, which prompted the FOMC to move away from an easing bias, remains a significant concern. Anchored inflation expectations suggest broad confidence in the Fed’s ability to contain price pressures, but that optimism could be tested. The Warsh Fed era may bring changes to Fed communication and balance sheet policy, potentially increasing volatility as investors reassess the FOMC’s reaction function. The Iranian/US MOU and ceasefire remain fragile, and adverse developments could raise energy and commodity prices by disrupting trade flows once again.

Historic AI spending presents multiple risks and opportunities. Technology spending is a growth catalyst and productivity enhancer, but it is also straining supply chains, adding to inflation. Additionally, aggressive capital raising across multiple sectors of fixed income is testing investor appetite. We are focused on both security selection and sector allocation to identify the optimal relative value opportunities within AI-related fixed income and to navigate AI disintermediation concerns. Beyond AI, we expect greater CEO confidence to drive higher levels of merger and acquisition activity and corporate actions that investors will need to navigate.

Our current strategy is to build resilient portfolios by leaning into the income component of fixed income. ABS, CMBS, and BBB 1-5 Corporates are appealing given the attractive yields and short durations, despite rich spread valuations. MBS provides incremental spread and favorable technicals. We will be tactical in building an MBS overweight given our concern about Fed induced rate volatility. We continue to believe diversification away from treasuries provides additional income and limits exposure to challenging supply technicals caused by increasing deficits.

Celebrating the 35th anniversary of Pugh Capital’s founding gave us reason to reflect on how society, technology, and fixed income markets have evolved. In fixed income, the information age and financial innovation have improved transparency, expanded investor participation, and boosted liquidity. Together, these changes have strengthened fixed income’s role as a source of income, diversification, and resilience in client portfolios.