Fixed-income markets saw increased volatility over the past month as tariff uncertainty affected trading conditions and widened mortgage-backed securities spreads. Although spreads and volatility remain low compared to historical levels, the recent rise echoes earlier tariff-related episodes, prompting leveraged investors to reduce their exposure. Treasury yields continue to compare favorably with foreign markets, with dollar-hedged global sovereign and corporate yields staying high relative to historic levels. Market positioning shifted to a modest short bias in the Treasury market for the first time since 2024, driven by stronger economic momentum and expectations of a steeper yield curve. The Federal Reserve’s policy outlook remains key to market behavior, with ongoing debates about the future size of the Fed’s balance sheet and the level of liquidity support needed to maintain stability in the world’s largest debt market.
UST yields are almost always below foreign bond yields, and the same holds for corporate bond spreads. While the dollar is weaker, a quality bias persists. However, if we are on the verge of a cyclical growth upswing, foreign corporations with strong balance sheets might be more appealing than sovereigns facing debt issues.
Federal Reserve policy debates centered on the stated goal of the presumptive Fed Chair to reduce the balance sheet. While this aimed to shrink the central bank’s footprint, structural changes since the financial crisis have increased the system’s reliance on central bank liquidity. Banks, dealers, and non-bank entities all depend on reserves and liquidity in ways that did not exist before 2008. Efforts to reduce the balance sheet could cause renewed instability, similar to the liquidity strains seen in 2025. As a potential compromise, policymakers might shift from traditional Federal Reserve asset purchases to “Treasury QE,” in which liquidity reaches the real economy through bank balance-sheet expansion rather than directly supporting asset prices. This approach could preserve credit availability while preventing further growth of the Federal Reserve’s balance sheet.
Credit and funding markets stayed mostly stable throughout the month. Companies with significant foreign revenue exposure experienced slight spread widening, although spreads remained below their 12-month highs. Credit performance continued to benefit from the economic cycle, as corporate bonds usually outperform Treasuries during growth periods. Short-term interest rates might decrease if labor conditions weaken and the Federal Reserve cuts rates again. Conversely, long-term rates could rise due to ongoing economic momentum and changes in Treasury issuance related to tariff developments. This environment has created conditions favorable for a gradual steepening of the yield curve.
Interest rate risks remain shaped by the balance between policy objectives and a rapidly expanding economy. Although the administration favors lower policy rates, strong real GDP growth of 4 to 4.5 percent limits the short-term potential for significant rate cuts. Yield curve movements continue to show upward pressure at the long end, along with market expectations of eventual easing. The outlook highlights ongoing risks for bond investors, including occasional volatility, tariff-related uncertainties, and changes in issuance. However, opportunities may arise in areas such as corporate credit, sectors benefiting from spread widening, and strategies that capitalize on curve steepening. While equity markets might not get strong support from this environment, fixed-income investors could find select opportunities as liquidity flows into the broader economy.
Sources: 3Fourteen Research, Strategas Research Partners LLC, and Capital Wars
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