U.S. election takes Treasury yields for a ride

Weekly fixed income update highlights

• Treasury yields were overall flat for the week.
• Investment grade and high yield corporates, structured products, preferreds, senior loans and emerging markets all had positive returns and outperformed similar-duration Treasuries.
• Municipal bond yields remained essentially unchanged. New issue supply was only $2.9B, and fund inflows were $1.6B. This week's new issuance is manageable at $5.6B.

U.S. Treasury yields were volatile after the U.S. election, but ultimately were little changed for the week. Fixed income broadly rallied on the improved prospects for tax cuts and better nominal growth. Separately, the U.S. Federal Reserve cut policy rates by 25 bps, as expected.

Watchlist

• 10-year U.S. Treasury yield was volatile but ultimately remained little changed for the week.
• Spread sectors gained substantially and outperformed Treasuries.
• Increased seasonal supply should provide an attractive entry point for municipal bonds.

Investment views

Rates have peaked for this cycle, and attention has pivoted toward the pace and size of rate cuts in response to softer growth and easing inflation.

The underlying growth outlook remains healthy thanks to strong consumer balance sheets and solid levels of business investment. This combination should keep corporate defaults low.

Risk premiums may widen further, with entry points for taxable fixed income likely to become more attractive over the coming quarters. Credit selection remains key as we search for bonds with favorable income and solid fundamentals.

Key risks

• Inflation fails to continue moderating as expected, weighing on asset prices.
• Policymakers unsuccessfully juggle fighting inflation with supporting economies still struggling to gain traction.
• Geopolitical flare-ups intensify around the world.

Investment grade corporate technicals are supportive

U.S. Treasury yields were mixed last week, as yields fell ahead of the U.S. election, rose sharply after the result became clear, and then declined again. Ultimately, the 10-year yield ended -8 basis points (bps) lower after trading in a 23 bps range. 2-year yields rose 5 bps, resulting in a flatter but modestly upward-sloping curve. Though a Republican red sweep was considered the base case entering the election, asset prices still moved sharply to price in expected policy changes. Separately, the Fed cut policy rates by 25 bps, as expected, and signaled additional cuts ahead. However, Chair Powell cautioned that the Fed could eventually change policy to counterbalance any changes to the macroeconomic outlook driven by fiscal policy.

Investment grade corporates rallied substantially, returning 0.75% for the week and beating similar-duration Treasuries by 68 bps. Spreads on the index tightened -9 bps to 74 bps, the tightest since 1998. The potential for tax cuts, deregulation and faster nominal growth combined to support valuations. At the same time, the technical backdrop remained very favorable, with sizeable inflows of $8.1 billion and minimal new supply. Issuance was light given the volatility in rates around the election, with only $2.6 billion pricing.

High yield corporates also gained, returning 0.74% and outpacing similar-duration Treasuries by 61 bps. Senior loans gained 0.26%, their 14th consecutive weekly advance. Steady inflows supported both markets, totaling $455 million and $448 million, in high yield and senior loans, respectively. High yield spreads tightened to 256 bps, the tightest since 2007. The move partially reflects the improvement in the overall ratings quality of the index. But even within ratings buckets, spreads are at their tightest since 2005 for BBs and since 2007 for single Bs. CCC rated corporates, though they have rallied substantially this year, still have somewhat wider spreads than the tights from 2021.

Emerging markets joined the rally, returning 0.84% and beating similar-duration Treasuries by 37 bps. Currencies of countries that may be exposed to tariffs experienced volatility. This weighed on returns in some cases, though ultimately the moves were modest. The Chinese renminbi weakened -0.77%, but the Mexican peso rallied 0.53%. There was no new issuance across the asset class, though outflows continued at -$3.2 billion.

Municipal bond demand remains strong

The municipal bond yield curve saw outsized volatility but ended last week basically unchanged. New issue supply was light due to the U.S. election and the November Fed meeting. Fund flows were positive for the 19th consecutive week, including $419 million in exchange-traded fund inflows. This week's new issue supply is very manageable and should be priced to sell.

The Treasury market should remain relatively stable now that the election is over and the Fed is cutting rates. However, some think Fed cuts may be few and far between in 2025, with the economy running hotter than previously thought. Government spending must be financed, and many expect outsized borrowing from the U.S. government will keep rates higher than anticipated.

The municipal bond market remains well bid, and we expect this trend to continue. Supply was undersized last week and is expected to be thin this week. However, issuance should pick up through the end of the year. But demand remains strong, as fund inflows continue from outsized reinvestment money on 01 November. We expect the same for 01 December.

High yield municipal bond yields ended slightly higher last week, but many areas of the market have not had time to adjust to the volatility. As a result, the high yield muni market sees a window of relative value opportunity after a period of sustained spread compression and a reduced pace of supply ahead. High yield muni fund inflows totaled more than $300 million through the reporting week ending 06 November, so any outflows from last week's volatility still need time to be observed. Nuveen is tracking what we believe is one of the last good weeks of supply with 17 deals coming. Monitoring the subscriptions on these deals will give us a good sense of how resilient demand remains.

Muni bond supply is expected to be thin again this week, but issuance should pick up through the end of the year.

In focus: The Fed keeps cutting

As expected, the Federal Reserve lowered its benchmark overnight borrowing rate by 25 basis points, to a target range of 4.50%-4.75%.

The Fed tweaked its policy statement, noting that "labor market conditions have eased," compared to September's "job gains have slowed"- a nod to the last two job reports that showed a slowing trend in hiring rather than the weakness seen earlier in the year. Regarding its dual mandate, the central bank continued to maintain that the risks to achieving its employment and inflation goals are "roughly in balance."

In his press conference, Chair Jay Powell reiterated that monetary policy is "not on a pre-set course," and the Fed will make upcoming policy decisions on a meeting-bymeeting basis. When asked about the impact of the election on monetary policy, he said that, at this point, "the election will have no effect." Powell further stated that the Fed will respond as needed to changes in fiscal policy - whether that requires rate hikes or cuts - but only once those fiscal changes are clear.

Looking ahead, we expect the Fed to reduce rates by another 25 bps when it meets next month. After that, Chair Powell and his colleagues could slow their pace of easing, thereby acting as a counterbalance to President-elect Trump's likely plans for renewed tax cuts and the prospects of wider fiscal deficits.

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