INSIGHTS

On April 21, 2025

AAM Viewpoints — First Quarter 2025 Fixed Income Update

The first quarter (Q1) seems like a distant memory with the heightened level of volatility we’ve witnessed in April. With stagflation concerns rising, investors have piled into Treasuries, pushing the 2-year and the 10-year 20bps (basis points) lower in the first week of April. In the second week of April, we had a reversal as rates pushed dramatically higher with the 10-year Treasury rising 50bps, marking the sharpest weekly increase in over two decades. These are certainly dramatic moves so rather than attempting to predict the next news headline, we want to look back at Q1 as the daily tariff updates continue to drive uncertainty in the fixed income market.

Even before the increase in volatility in April, market expectations at the end of Q1 were pricing in three rate cuts by the end of 2025, two of which were priced to occur by September. Clearly, market odds of a recession have risen recently as both PCE (personal consumption expenditure) and the University of Michigan survey indicators highlight ongoing and notable economic softening. The markets are perhaps digesting the probability that the FOMC (Federal Open Market Committee) will face the challenge of rising inflation levels combined with a slowing economy.

The message from the Federal Reserve has been the direction for rates is lower while the pace may be slower than previously expected. The first quarter was relatively calm during the first 2 ½ months before 10-year Treasury rates dropped 34bps in the last two weeks in March. The Bloomberg U.S. Aggregate Index posted a 2.78% return in Q1 after returning only 4bps in March. As you can see below, the Treasury component was the largest contributor to overall performance in the index during March with a gain of 23bps in a month with very lackluster returns.

Source: AAM – Bloomberg Barclays Live | Past performance is not indicative of future results.

Treasuries

The unexpected calm in rates during November is a distant memory as U.S. Treasury yields across the breadth of the curve declined dramatically in Q1 with 2s and 10s down 36bps and 5s down 43bps. The 2s/10s (2-year Treasury vs 10-year Treasury) yield curve finished the quarter at 32bps after peaking at 42bps on January 14. The move lower in rates during the quarter generated positive returns in benchmark Treasury indices.

In Q1, the ICE BofA ML US Treasury Index was up 3.00%, the fourth largest quarterly return since Q1 2020, and is up 4.52% over the trailing 12 months. The index finished the quarter with a 4.12% yield-to-worst, a duration of 6.13, while the trailing 10-year average yield-to-worst for the index is only 2.38%.

Volatility was subdued in Q1, as reflected in the ICE BofA ML MOVE Index which finished March at 101, which was up less than 1%. However, April has been much more volatility and this does not mean you avoid the asset class, but investors should be selective in positioning assets.

Past performance is not indicative of future results.

Municipal Market

The ICE BofA ML U.S. Municipal Bond Index posted a total return of -0.50% in Q1 with a price return of

–1.54% and income return of 1.08% for the quarter. The trailing 12-month total return is 1.39% during the period with the income component contributing 4.37% which further reinforces the importance of income in the total return calculation.

The 10-year Municipal-to-Treasury ratio — a popular metric to measure relative value for tax-exempt debt — finished Q1 at 76.13%, the cheapest level since November 28, 2022 (77%). The 30-year ratio finished March at 92% which is also the cheapest level since November 2, 2023 (92%). The yield-to-worst for the broad IG (investment grade) Municipal Index ended March at 3.90%, 31bps higher during the month, after peaking at 3.98% on March 27.

Municipal new issuance in Q1 was $120 billion and exceeded last year’s total for Q1 by 20%. This year it appears issuance was being pulled forward to get ahead of legislative changes as sentiment remained positive as average weekly inflows totaled $1 billion.

Credit Market

ICE BofA ML U.S. IG Corporate Index yields remain attractive and finished the quarter with a yield-to-worst of 5.16% which is 20bps lower year to date (YTD). Although that is lower on the year, it remains well above the trailing five-year average of 4.07%. In March, borrowers priced $193 billion in new issuance pushing Q1 totals to a record $561 billion as investors continue to digest the pace of offerings with orderbooks averaging 3.5x oversubscribed.

Falling Treasury yields and wider spreads led to negative excess returns in the ICE BofA ML U.S. Corporate IG Index in Q1 at -0.86%. On a total return basis, the Index finished the quarter with a return of 2.37% with intermediate tenor bonds outperforming. 5-7-year tenors posted a total return of 2.83% while 1-3-year tenors posted a 1.65% return. Corporate bonds generally faced headwinds last year with the ICE BofA ML U.S. IG Corporate Index posting an 2.76% total return, Q1 presented better results but there was a noticeable uptick in volatility in late March. The risk-off sentiment prompted investors to focus on the high end of the rating spectrum, leading to outperformance in higher rated IG as the excess return in the ICE BofA ML U.S. AAA index was -0.95% and the total return was 2.61% in Q1 to be the top performer by rating in IG.

HY corporates finished the quarter with a yield-to-worst of 7.73% which was 57bps higher in March and 26bps higher in 2025. Across ratings, yields are above 6% with the largest pick-up of 544bps when moving from BB rated to CCC rated bonds. Yields are 26bps higher this year and they remain 103bps higher than the trailing 10-year average of 6.70%. The ICE BofA ML U.S. High Yield Index posted an excess return of -1.30% and a total return of 0.95% in Q1 and has a trailing 12-month total return of 7.60%.

HY (high yield) primary market remained active in March with 31 issuers pricing $26 billion, which is slightly above the long-term average for March at $22 billion. Although the YTD total issuance is lower than Q1 2024 ($86 billion), it was a respectable $68 billion. Pricing softened as deals in March widened an average of 20bps from initial price talk as borrowing costs moved higher with macroeconomic conditions deteriorating. New coupons rose 14bps to 7.68%.

Past performance is not indicative of future results.

Credit Spreads

ICE BofA ML US IG Option Adjusted Spreads widened in Q1 as IG spreads reached 97bps (+15bps YTD) and HY reached 355bps in March (see chart below). The front end of the curve moved the least in Q1 with 1–3-year tenors wider by 5bps and 5–7-year tenors wider by 17bps.

The ICE BofA ML U.S. Corporate AAA Option Adjusted Spread finished Q1 at 44bps (+10 bps YTD) over Treasuries while the ICE BofA ML U.S. Corporate BBB Option Adjusted Spread finished at 120bps (+18bps). The yield pick-up from dropping from AAA rated to BBB rated bonds finished the quarter at +55bps with only 75% of the duration exposure.

At the sector level, IG spreads widened in Q1 with Automotive (+26bps), Utilities (+20bps) and Leisure (+19bps) moving the most. Banking (+9bps), Healthcare and Transportation (+10bps) moved the least.

Spreads in ICE BofA ML U.S. HY Index widened 63bps in Q1 with BB rated spreads moving the least +38bps. B rated spreads widened by 72bps. It should be no surprise that the largest moves wider in HY spreads were during the last week of March (+50bps) as equity volatility increased.

Past performance is not indicative of future results.

Yield Curve

The spread between the 30-year U.S. Treasury yield and the 5-year U.S. Treasury yield steepened from 40bps at the end of 2024 to 62bps on March 29th. While the 30-year minus the 5-year curve is 22bps steeper this year, the 10-year minus 2-year is unchanged and finished the quarter at 32bps. The chart below reflects that only 10-year minus 3-month T-bills finished the quarter inverted. 10s and 2s curve has been positive since September 2024 after being inverted for 783 consecutive days.

Summary

It was only a few weeks ago that the economy was viewed as stable with adequate growth data from Payrolls, Personal Income and Spending, Manufacturing PMI and Initial Jobless Claims holding steady. March Inflation data surprised to the downside as headline CPI (consumer price index) dropped 0.1% month over month (m/m), PPI (producer price index) fell by 0.4% m/m and PCE estimates are 0.0% m/m. Then, the Trump Administration announced a package of broad and larger-than-expected tariffs, which created a spike in equity and bond volatility. Equity (VIX) and rates (MOVE) volatility indices surged to levels on par with prior liquidity crises such as COVID and the Great Financial Crisis.

With stagflation concerns rising, investors piled into Treasuries, pushing the 2-year and 10-year yields 26bps lower in the first week of April to 3.65% and 3.99%, respectively. These are levels last seen in October 2024 when economic slowdown concerns also unsettled markets. This volatility will likely remain for the foreseeable future as Cliff Corso pointed out in the April 3 Viewpoints. The ‘Triple Threat of T’s’ – Tariffs, Trade and impending battle over Taxes concern exists while the expectation for inflation to remain sticky leads to uncertainty around interest rate policy.

At times like these, we remind investors to focus on long-term investing and look beyond the headlines. The headlines may add volatility in fixed income assets, but we believe investment grade corporate bonds appear attractive for investors looking to earn higher yields without taking too much additional credit risk. The ICE BofA ML US Corporate IG Index yield-to-worst at the end of March was 5.16% and as of this writing is 5.44%. When evaluating these opportunities remember to stay within the investor’s risk tolerance and expect volatility to remain elevated as we anticipate economic growth may continue to slow. Bonds provide investors with a defined stream of income and a maturity date to potentially reduce the concern of price volatility over the shorter term.

This environment presents both opportunities and risks for fixed income investors. This is the time to understand where the risk lies in your fixed income portfolio and hiring a professional management team with an experienced track record may help investors sleep better at night during this stage of the cycle. Active managers will diversify portfolios across asset classes, sectors, maturities and tactically adjust duration as needed.

CRN: 2025-0403-12454 R