Taxable Fixed Income Q2 2025 Commentary 

“In like a lion, out like a lamb” is an apt metaphor for capital markets in the second quarter. On April 2, 2025, the roar of Liberation Day tariffs rattled global markets. However, President Trump subsequently reduced the proposed tariff levels, and markets rebounded strongly. A steady stream of notable headlines followed, including, but not limited to the Moody’s U.S. downgrade, questions about the Federal Reserve’s independence, the One Big Beautiful Bill (OBBB) Act and its impact to the U.S. fiscal deficit, and rising tensions in the Middle East. Despite the deluge of news, the quarter ended with economic and market data seemingly unconcerned with those headlines. Equities posted strong returns during the quarter, while credit performed well as spreads narrowed back to recent lows. Unemployment and inflation data remained steady, and business and consumer sentiment improved from Liberation Day lows. Market predictions shifted to a higher-for-longer Fed stance.

The second quarter showed why interest rate timing is a challenging undertaking. The yield curve inverted further from zero to three years and steepened from three to 30 years as uncertainties regarding Fed rate cuts, inflation, and growth persisted. The next Fed decision is scheduled for July 30, 2025. Investors predict the Fed will not cut rates then, with mixed opinions on whether the Fed cuts rates at all during the third quarter.

Fixed income indexes enjoyed positive total and excess returns during the quarter. Riskier segments of the market outperformed higher-quality indexes as credit spreads narrowed. The Bloomberg Aggregate Index returned 1.2%, while the JPM Leveraged Loan Index returned 2.4% and the Bloomberg High Yield Index returned 3.5%.

Credit issuance was mixed during the quarter despite a lull of deals during the depths of market volatility in April. Investment-grade corporate bond issuance matched last year’s pace, while private label commercial mortgage-backed securities (CMBS) volumes are up 61% year over year. Issuance in several sectors was lower than their record-setting paces of 2024, yet volumes did not crater, and high-quality issuers can continue to access the markets. Volumes of nontraditional asset-backed securities (ABS), high-yield corporate bonds, and loans were down 9%, 15%, and 37%, respectively, year over year.

With narrower spreads, strong fixed income fund flows, and mixed issuance, credit valuations weakened during the quarter. Investment-grade corporate bond “buys” decreased to 8% from 11%, to 27% from 38% for high yield, and to 43% from 45% for loans. Agency mortgage-backed securities (MBS) remain wholly unattractive, with no 15- or 30-year coupon cohort screening as a “buy.” Away from credits in mainstream indexes, ABS index spreads narrowed, though performance varied by subsector. Higher-quality CMBS spreads narrowed as spreads of BBB-rated multifamily and mixed-use CMBS widened. Spreads on collateralized loan obligation (CLO) debt narrowed further from already tight levels.

As always, there are idiosyncratic opportunities in distinct corners of the credit markets. Investment-grade corporate bonds in interest rate-sensitive industries offer opportunities, and many bonds with short to intermediate durations screen favorably. The corporate loan market continues to offer opportunities across the spectrum of deal sizes. Most high-yield opportunities reside in selective and smaller issuers. Tariffs and fiscal policy uncertainty have also affected several high yield industries’ valuations and created opportunities. Spreads of several ABS subsectors and single-asset, single-borrower (SASB) CMBS property types have moved near their long-term averages.

We continue to avoid certain segments that we believe have enduring credit issues. Emerging market credit remains unappealing to us due to concerns over creditor rights in most countries and its impact on their durability. We find nonagency residential mortgage-backed securities (RMBS) plagued by erratic issuance trends, unattractive valuations, and weak fundamentals.

Credit dynamics are generally healthy, with losses and delinquencies of business loans, consumer debt, and commercial real estate loans generally at manageable levels. Businesses have weathered recent uncertainties well. Default rates are lower across the high-yield market, although the default rate on loans continues to be well above those for bonds. Delinquencies and charge-off rates of business loans at commercial banks have stabilized, and nonaccrual rates of loans held by business development companies (BDCs) crept higher yet remain at manageable levels.

Delinquency rates and charge-offs on consumer loans held at commercial banks increased, yet not to levels that raise concerns about systemic losses that might impact securitizations. While auto loans, bank credit cards, and mortgage delinquencies have only modestly increased, federal student loan payments resumed during the quarter, causing a spike in delinquency rates on student loans. It is questionable whether the resumption of student loan payments will have a spillover effect into other types of consumers’ debt. Strong credit underwriting remains imperative to navigating debts backed by or tied to consumers.

Delinquency rates on commercial real estate varied by sectors and deal structures. Office delinquencies revealed a divergence by deal structure: Office loans in conduits continued to rise, while SASB delinquencies moderated. Multifamily delinquencies increased to recent highs across deal structures. In retail, hotel, and industrial sectors, SASB and conduit delinquency rates converged at similar levels quarter over quarter. Delinquency rates and charge-offs of commercial real estate loans held at commercial banks remain subdued, indicating that market stress has not impacted banks’ credit portfolios to date.

If you could go back in time to last fall, and show an investor this quarter’s headlines, we suspect they would be shocked by the buoyancy of the stock market and rich valuations of credit. We believe that selectivity regarding both valuations and durability are imperative for attaining favorable credit performance moving forward. Complacency may be creeping into some segments of the market, but we remain steadfast in our approach. We maintain attention to factors that underlie an issuer’s durability, such as underwriting standards, financial and operating flexibility, and prudent capital structures. Such an approach helps our clients’ portfolios perform through unpredictable times.