Q4 2025 Taxable Fixed Income Commentary

The Bloomberg U.S. Aggregate Index advanced 1.1% in fourth quarter 2025. The return was driven by lower short-term interest rates following Federal Reserve (the Fed) rate cuts, stable intermediate-term rates, and positive excess returns to credit across most sectors. These factors offset negative pressures from higher long-term rates and negative excess returns from long-maturity corporate bonds. Indexes of high-yield corporate bonds and loans each returned 1.3%, outperforming investment grade bonds after controlling for the effects of duration.

The Fed cut the federal funds target range twice by a total amount of 0.50% to 3.50% to 3.75%. The yield curve steepened during the quarter, with short-term rates moving lower while long-term rates increased. The Fed’s next announcement date is January 28, 2026, and market estimates are for the Fed to cut rates by a total of 0.50% over the course of 2026. Significant attention will be on the Fed in 2026 as Chairman Jerome Powell’s term comes to an end in May, and there are questions about the degree to which political influences may impact monetary policy under a new Chairperson.

U.S. fiscal policies, trade policies, and geopolitical tensions made headlines during the year. The One Big Beautiful Bill Act (OBBBA) enacted tax cuts and spending reductions that impacted many policies, including the phase-outs of several clean energy tax breaks tied to electric vehicles and solar energy, changes to several federal student loan programs, and the elimination of some Affordable Care Act (ACA) subsidies. Congressional opposition to the expiration of these ACA subsidies resulted in a record-breaking shutdown of the U.S. government that ended with an extension of these subsidies for three years. Tariff announcements produced significant market volatility during second quarter 2025. However, the market quickly absorbed the tariff changes even as any potential inflationary impact remains unknown. Escalations of geopolitical tensions in Ukraine, Gaza, Iran, and Venezuela commanded headlines throughout the year. Despite this barrage of newsworthy headlines, the Bloomberg U.S. Aggregate Index posted a full-year 2025 total return of 7.3% as interest rates declined and credit excess returns were positive across sectors.

Credit valuations remained broadly unattractive as credit spreads narrowed throughout the year. According to our valuation framework, there were few “buy” opportunities in mainstream indexes at quarter end.¹ Only 4% of investment grade corporate bonds, 15% of high-yield corporate bonds, and 0% of agency mortgage-backed securities (MBS) met our valuation purchase criteria. Collateralized loan obligation (CLO) debt spreads remained near their recent lows.

Notwithstanding, there are pockets of opportunity. In the investment grade corporate bond market, over 20% of shorter-maturity single-A bonds meet our criteria for purchase, over 30% of bonds issued by life insurers and finance companies screen favorably, and we have identified a few small idiosyncratic opportunities as well. Nearly half of corporate loans screen as “buy” candidates according to our valuation framework. In the structured credit markets, opportunities are emerging as valuations are improving in several subsectors. As nontraditional ABS spreads widened, spreads in certain subsectors have become appealing. Single-asset single-borrower (SASB) commercial mortgage-backed securities (CMBS) subsector spreads remained near their longer-term averages.

Credit issuance was generally strong, and markets have been open to issuers seeking to raise capital or refinance existing debt. Investment grade corporate bond volumes increased 4% year over year, ABS issuance was up 9%, and nonagency CMBS volumes surged 40% in 2025. High-yield bond volumes increased 9%, but loan volumes decreased 26% year over year.

One theme that permeated issuance across credit sectors was the increase in data center financing deals to fund the enormous demand for artificial intelligence (AI) infrastructure. The scale of issuance was notable: We estimate $300 billion of investment grade corporate bond volumes were tied to such projects in 2025, representing 16% of high-grade corporate issuance. We estimate that data center and fiber ABS issuances represented 8% of ABS volumes in 2025 (up from 4% in 2024) while data center SASB CMBS deals were 8% of nonagency CMBS volumes (up from 2% in 2024). These financings included both established and first-time issuers, various deal structures, and different levels of protection from equity or asset pledges. We believe our time-tested approach to identifying durable credit investments in such deals should help our client portfolios navigate potential volatility tied to AI headlines or risk events.²

The U.S. economy proved resilient amid an eventful political landscape. Consumer spending remains strong, although there are concerns over a K-shaped economy forming from the divergence between the spending of higher- and-lower-income consumers. Consumer sentiment indexes sit at weak levels, with concerns about high prices and a softening labor market weighing on consumers. Credit performance of consumer-related debt and loans suggest a “normalization” of credit losses – above the stimulus-induced lows of the recent past and well below those experienced in recessions. The resumption of payments on federal student loans has not yet had a meaningful impact on delinquencies in payments on other types of consumer debt, such as credit cards or auto loans.

U.S. business performance remains strong. The quarter began with fears that private credit losses could accelerate and reduce the returns in this recently popular segment of credit markets. For example, there were two significant defaults that arose from instances of fraud: Tricolor and First Brands. While the impact of those defaults was relatively contained, larger-scale concerns emerged regarding potentially relaxed lending standards. Equity of business development companies (BDCs) traded at a 10% discount to their net asset value, rivaling lows last experienced in 2023. In the fixed income markets, credit spreads on BDC debt widened marginally, while spreads on CLO debt were relatively stable.

We have not observed evidence of a broad increase in default activity. The data reveals that default rates and loss statistics have normalized. The default rate of leveraged credits (high-yield bonds and syndicated loans) stood near its longer-term average at 3.1%. The default rate of loans held in private credit CLOs remains near the default rate of the broader leveraged credit market and near its longer-term average. BDC credit performance weakened slightly, but remained resilient, with nonaccrual rates ticking up only slightly while rates of realized losses and write-downs remained subdued. Charge-offs and delinquency rates of business loans held at U.S. commercial banks increased only slightly and remain well below levels experienced during recessions. We believe that any increase in private credit defaults, or losses, will drive dispersion in credit performance across issuers.

Volatility is a feature of markets, and a built-in assumption and driver in our valuation process. We do not know what will cause the next bout of market volatility. Credit markets sit at a point of low to very low credit spreads in many major sectors. Periods of broadly unattractive credit valuations necessitate strong purchase and sale disciplines, a method of evaluating attractiveness of individual bonds, and careful selection accentuated by robust credit research. We are confident that credits owned in client portfolios meet our tests of durability while offering appropriate compensation for the risks assumed. Further, we believe our clients’ portfolios are positioned to navigate opportunities that arise when valuations become more appealing.