Taxable Fixed Income Q1 2026 Commentary

The Bloomberg U.S. Aggregate Index had a slightly negative return during first quarter 2026 as interest rates and credit spreads rose slightly. Interest rates rose across all tenors as oil prices surged with the onset of conflict in Iran, spurring inflationary concerns and weaker prospects for Federal Reserve (Fed) rate cuts in 2026. Index credit spreads widened marginally from historically low levels. High-yield bonds and loans had slightly negative returns of -0.5% and -0.4%, respectively, and underperformed investment grade bonds.

Several events drove headlines during the quarter. Three noteworthy events impacted markets: the potential for artificial intelligence (AI) to disrupt software companies, elevated redemptions and limits in business development companies (BDCs), and the onset of the conflict in Iran and its impact on oil shipments and prices. Each development brings concerns, particularly as AI disruption and BDC redemptions impact conditions in the direct lending industry and the rise in oil prices begins to impact consumer prices.

When it comes to the market impacts of these headlines, the bark seems worse than the bite. Broad measures of private credit fundamentals indicate that defaults are rising toward historically normal levels. The U.S. consumer appears resilient, with delinquency and charge-off rates on most types of consumer loans in-check. In the credit markets, software companies’ spreads widened in the loan market and BDC bonds’ spreads widened. However, at the broader sector levels, credit spreads widened only marginally to levels far lower than they have in past episodes of market anxiety. This may be explained partially by the magnitude of bond fund inflows that occurred as investors flocked to the safety of bonds given higher nominal interest rates.

With the general widening of credit spreads, valuations improved and opportunities arose in select pockets of the market; however, it is hardly a “fire sale” as spreads remain closer to their historical lows than their long-term averages. In the corporate credit markets, the percentage of the universes screening as potential “buy” opportunities increased to 10% from 4% for investment grade bonds, to 23% from 15% for high-yield corporate bonds, and to 55% from 48% for loans. Away from corporate credit, there remains no coupon cohort of the agency mortgage-backed securities (MBS) market that screened as a “buy” candidate according to our Valuation Framework. In the structured credit markets, spreads of nontraditional asset-backed securities (ABS) and collateralized loan obligation (CLO) debt widened towards historical averages, while spreads of single-asset single-borrower (SASB) commercial mortgage-backed securities (CMBS) were little changed during the quarter and near their historical averages.

Opportunities remain throughout the credit markets, though selectivity is imperative. Within the investment grade corporate bond market, over 40% of names of finance companies, life insurers, and specialty finance companies meet our criteria for purchase. There remains an abundance of opportunities in shorter-maturity bonds (under five years). In the high-yield market, there remains an abundance of “buy” opportunities in the media/telecommunications sector, as well as in three sectors impacted by higher oil prices: transportation, chemicals, and energy. Opportunities emerged in several structured credit sectors, including SASB CMBS, data center ABS, subprime auto ABS, personal consumer loan ABS, and broadly syndicated loan (BSL) CLOs.

Credit issuance was resilient amid cautious headlines and volatility, and issuers were met with generally favorable conditions as investors flocked to bond funds in the first quarter. Volumes of investment grade corporate bonds increased 12%, high-yield bonds increased 15%, nontraditional ABS increased 14%, nonagency CMBS increased 6%, and CLO increased 8% year over year. Leveraged loan volumes were flat vs. the strong pace of 2025.

Credit fundamentals indicate healthy and resilient performance of commercial, consumer, and real estate loans. Default rates of high-yield corporate bonds and loans sit near their longer-term averages. Measures of default activity in direct lending converge in a range of 3% to 5%, higher than recent lows but consistent with long-term averages. Consumer sentiment remains weak in the face of affordability concerns and recent increases in transportation costs, but delinquency and loss rates of many types of loans – including credit cards, autos, unsecured loans, and home improvement loans – have stabilized at normalized levels. Commercial real estate loan performance has steadied, with banks reporting minimal charge-offs and losses. Credit performance in SASB deal structures has normalized, with delinquency rates stabilizing and losses remaining low.

A core tenet underlying our investment process is that credit valuations tend to be far more volatile than underlying fundamentals. Determining what signal is being sent by evaluating index spreads is of less interest to a bottom-up credit manager like BBH. Instead, we are evaluating opportunities that are emerging and determining whether to shake with fear or embrace these concerns as a reason to invest in situations where valuations have become disconnected from otherwise strong fundamentals.