Highlights
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Third Quarter 2025 in Review
U.S. fixed income markets posted solid returns during third quarter 2025 as interest rates declined across the curve, the Federal Reserve (the Fed) cut rates, and credit risk spreads narrowed further. All mainstream indexes had positive total returns and excess returns to credit.
Credit risk spreads were lower across all major indexes, and, for many indexes, quarter-end index spreads declined to levels last experienced in the late 1990s. The Bloomberg U.S. Corporate Index’s quarter-end spread hit its lowest month-end level since May 1998, while month-end spreads of double-B and single-B corporate bonds were lower at quarter-end only four times over the past 30 years. Structural changes to the composition of broad investment grade and high yield corporate bond indexes may provide reasons for these low spread levels. Looking forward from these spread levels, expected credit returns are meager and negative in many instances.
Unsurprisingly, the BBH Valuation Framework1 indicates a very low level of appropriately valued opportunities. The Framework showed that 3% of investment grade corporate bonds, 44% of corporate loans, 24% of high-yield corporate bonds, and no segment of the agency mortgage-backed securities (MBS) market met our criteria for purchase at quarter-end. Spreads of collateralized loan obligation (CLO) debt and many nontraditional asset-backed security (ABS) subsectors sit at the narrowest ends of their historic ranges. However, there remain opportunities in pockets of the credit markets. For example, there are opportunities for incremental yield in shorter maturity, high-grade corporate bonds. Debt of smaller issuers also screens favorably within the high yield bond and loan markets. Several nontraditional ABS subsectors screen attractively, and spreads of many commercial mortgage-backed security (CMBS) subsectors are at or above the medians of their historical ranges.
Both supply and demand for credit continue to be very strong. Credit issuance was strong vs. the subdued volumes from last quarter on account of lower interest rates and narrower credit risk spreads. Investment grade corporate bond issuance was in line with last year’s record-setting pace, while leveraged corporate debt issuance decreased 7% year over year. Leveraged corporate issuers increasingly chose bond issuance, where volumes were up 6% over last year, vs. loans (down 11%). ABS volumes were down 2% from 2024’s pace for both traditional and nontraditional subsectors. Nonagency CMBS issuance was robust, with 40% more issuance than last year. Meanwhile, taxable bond fund flows are on pace to have one of the strongest calendar years on record. According to research from Barclays, new issues of investment grade corporate bonds have been approximately four times oversubscribed, with yields driven lower by 0.25% from their announcement to final pricing. Debt markets are open to issuers looking to refinance or raise new capital.
Generous refinancing availability tends to obscure cracks in credit quality; however, there are several trends that suggest the durability of issuers may be tested in the near future. Signs of stress are emerging for lower-income U.S. consumers. These consumers’ wages have not kept pace with the inflationary environment of 2022–2023, and high prices continue to impact spending choices. These inflationary dynamics will likely continue over the next 12 months. Prices of nonessential commodities such as coffee and chocolate have surged and are shifting consumers’ spending patterns towards staple goods. In addition, the price of federal healthcare programs is expected to increase by a median 18% in 2026 with the expiration of Affordable Care Act subsidies. Labor market conditions are a reason for concern, as wage growth has moderated and non-farm payrolls sit near their weakest levels in over 15 years (excluding the months following the onset of COVID-19). There are many loan credit performance indicators that suggest these trends are beginning to impact credit markets. Subprime auto loan default rates are near the higher end of their historical range. Delinquency rates of student loans are elevated after the U.S. government’s forbearance program ended, yet the resumption of student loan payments has not yet appeared to impact delinquency rates of other types of consumer loans.
U.S. business conditions appear stronger. Default rates continue to moderate, delinquency rates and charge-offs of business loans remain subdued, and loan performance within CLOs and business development companies (BDCs) remains strong. There are significant infrastructure capital expenditures being made to support artificial intelligence (AI) ambitions, and they are being financed through the corporate and structured credit markets. With narrow spreads and many of these projects facing uncertain outcomes, strong credit research is paramount for navigating the increasing breadth of opportunities.
Strong credit research is always a necessary ingredient for attaining sustainable credit performance, and it is perhaps no surprise that our credit research identifies many issues that offer attractive yields but do not possess the durability features we seek. However, opportunities remain in every market. In environments of low-risk spreads and sparse opportunity, we believe that the virtues of a bottom-up process build portfolios of durable credits at attractive yields that can prevail in economic uncertainty and benefit our clients’ performance journey.
1 Our valuation framework is a purely quantitative screen for bonds that may offer excess return potential, primarily from mean reversion in spreads. When the potential excess return is above a specific hurdle rate, we label them “Buys” (others are “Holds” or “Sells”). These ratings are category names, not recommendations, as the valuation framework includes no credit research, a vital second step.
Index Definitions
Ice BofA U.S. Corporate Index tracks the performance of USD denominated investment grade corporate debt publicly issued in the U.S. domestic market. Bloomberg U.S. Corporate Bond Index represents the corporate bonds in the Bloomberg US Aggregate Bond Index, and are USD denominated, investment-grade (rated Baa3 or above by Moody’s), fixed-rate, corporate bonds with maturities of 1 year or more.
Bloomberg U.S. Aggregate Bond Index covers the USD-denominated, investment-grade (rated Baa3 or above by Moody’s), fixed-rate, and taxable areas of the bond market. This is the broadest measure of the taxable U.S. bond market, including most Treasury, agency, corporate, mortgage-backed, asset-backed, and international dollar-denominated issues, all with maturities of 1 year or more.
Uniform Mortgage Backed Security (UMBS) means a single-class MBS backed by fixed-rate mortgage loans on one-to-four unit (single-family) properties issued by either Enterprise which has the same characteristics (such as payment delay, pooling prefixes, and minimum pool submission amounts) regardless of which Enterprise is the issuer
“Bloomberg®” and the Bloomberg indexes are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indexes (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Brown Brothers Harriman & Co (BBH). Bloomberg is not affiliated with BBH, and Bloomberg does not approve, endorse, review, or recommend the BBH Strategy. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to the fund.
The Indexes are not available for direct investment.
Risks
Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, maturity, call and inflation risk; investments may be worth more or less than the original cost when redeemed.
Asset-Backed Securities (“ABS”) are subject to risks due to defaults by the borrowers; failure of the issuer or servicer to perform; the variability in cash flows due to amortization or acceleration features; changes in interest rates which may influence the prepayments of the underlying securities; misrepresentation of asset quality, value or inadequate controls over disbursements and receipts; and the ABS being structured in ways that give certain investors less credit risk protection than others.
Brown Brothers Harriman Investment Management (“IM”), a division of Brown Brothers Harriman & Co. (“BBH”), claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.
To receive additional information regarding IM, including a GIPS Composite Report for the strategy, contact John W. Ackler at 212 493-8247 or via email at john.ackler@bbh.com.
Basis point is a unit that is equal to 1/100th of 1% and is used to denote the change in price or yield of a financial instrument.
Traditional ABS include prime auto backed loans, credit cards and student loans (FFELP). Non-traditional ABS include ABS backed by other collateral types.
Issuers with credit ratings of AA or better are considered to be of high credit quality, with little risk of issuer failure. Issuers with credit ratings of BBB or better are considered to be of good credit quality, with adequate capacity to meet financial commitments. Issuers with credit ratings below BBB are considered speculative in nature and are vulnerable to the possibility of issuer failure or business interruption. High yield bonds, commonly known as junk bonds, are subject to a high level of credit and market risks.
Opinions, forecasts, and discussions about investment strategies represent the author’s views as of the date of this commentary and are subject to change without notice. The securities discussed do not represent all of the securities purchased, sold, or recommended for advisory clients and you should not assume that investments in the securities were or will be profitable.
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IM-17430-2025-10-21 Exp. Date 01/31/2026
