INSIGHTS

On November 10, 2025

Fixed Income & Asset Class Outlooks, and Key Market Risks

Asset markets took a firmer tone through the third quarter of 2025. The Federal Reserve’s (Fed’s) decision to restart its easing cycle in September — prompted by signs of labor market softening — underpinned the change in sentiment, but markets continue to grapple with the aftershocks of earlier tariff announcements and a still uncertain outlook. Looking ahead, we anticipate that ongoing U.S. tariff uncertainty will continue to weigh on growth and keep inflation risks elevated. While near-term economic indicators remain resilient, structural shifts in global trade and persistent policy uncertainty are likely to constrain economic momentum into 2026. That said, we do not expect the economy to tip into recession. The AI (Artificial Intelligence)-driven investment cycle could provide enough support to offset the weakening labor market.

Market Outlook

Although we believe the U.S. will avoid recession, we expect growth to slow to between zero and 2% over the near term, which is historically the type of environment that has suited bonds more than equities.

Average 1-year return through periods where growth is between 0% and 2%

Past performance is not indicative of future results. Source: Bureau of Economic Analysis, Insight; as of June 2025 (time period 1984 to Q1 2025). Charts are provided for illustrative purposes and are not indicative of the past or future performance of any product.

But with credit spreads having retraced their “Liberation Day” widening, we think active management will be key to extracting the most value. For example:

• We think the front and intermediate areas of the yield curve could benefit from the Fed’s rate cuts. The long end, on the other hand, may be vulnerable to ongoing concerns about deficits and other risks.

• We think investment grade and high yield corporate bonds offer value despite the level of spreads, particularly higher quality credits and less tariff-sensitive sectors, such as banks and utilities.

• Asset-backed securities could also help enhance yield and add diversification, particularly in less mainstream “esoteric” sectors, such as data centers and fiber.

• We also see value in emerging market companies that could benefit from the reshaping of global trade. Less global central bank coordination also creates relative-value opportunities across markets.

ASSET CLASS OUTLOOKS

Investment grade credit:

Supply of U.S. dollar corporate bonds has increased but has been outweighed by strong investor demand, supporting the gradual tightening of spreads. Spreads are near the tighter end of historical ranges, but this could persist for some time given demand. Notably, in the 1990s, credit spreads tightened to similar levels but then narrowed further after the Federal Reserve began cutting rates.

Absolute yield levels remain a key driver for investor demand, and we expect this to persist with the United States able to avoid recession as AI-driven business investment offsets a softening labor market and a central bank that is widely expected to cut rates further.

In Europe, corporate bond spreads offer the potential for better value, although investor interest is growing; the easing of Germany’s debt brake should support eurozone growth and present significant opportunities for security selection. Valuations in sterling credit lie somewhere in between, although economic growth is unlikely to benefit from either a rate cut or fiscal stimulus. Globally, we remain cautiously constructive, favoring selective exposure to higher-quality issuers, with a modest tilt toward defensive sectors and euro-denominated debt where appropriate as we wait for broader valuations to improve.

High yield credit:

The asset class has become an increasingly attractive hunting ground for investment grade portfolios seeking incremental yield given the compression of spreads in higher-rated credit. This trend has been underpinned by a narrowing rating differential, as an increasing share of high-yield issuers migrate toward the highest BB rating, while investment grade markets continue to drift towards a BBB rating. Buoyant demand stands in contrast with modest issuance, with many issuers having already prefinanced their 2026 and 2027 maturities. Tariffs, and their broader impact on growth, remain a concern, and require careful consideration as we make new investments within active portfolios. However, many high-yield issuers manufacture and sell locally rather than internationally, which helps to mitigate the impact of tariffs. Overall, we continue to believe the environment remains attractive for high-yield issuers, many of which boast strong balance sheets and robust cashflows. Defaults remain low, and this likely represents a structural shift for high yield markets, with smaller and distressed issuers turning to private credit markets where there is far greater flexibility to restructure debt when necessary.

KEY MARKET RISKS

Forecasting uncertainty raises risks: A heightened level of policy uncertainty is making forecasting increasingly challenging, with significant implications for both investors and the Fed. While a softening labor market may offer the Fed some short-term flexibility, history provides few precedents for rate cuts when inflation remains well above target and fiscal deficits are so wide. This context should encourage caution from policymakers, but mounting political pressure for aggressive easing means even this is uncertain.

The new tariff regime pushes the world into recession: The new U.S. tariff regime has started to tilt the balance of risks for growth to the downside. Economic data has proved resilient in the short term, but we expect it to soften in the months ahead. Although not our base scenario, there is a risk that the global economy tips into recession.

An unpredictable geopolitical backdrop: Geopolitical tensions remain elevated, creating an unpredictable backdrop where events can quickly escalate or de-escalate, creating significant market volatility. The ongoing rivalry between the United States and China continues to dominate global affairs, with trade disputes, technological competition, and military posturing in the Indo-Pacific region intensifying.

CRN: 2025-1107-12996 R

The opinions and views of this commentary are that of Insight Investment and are not necessarily those of Advisors Asset Management. Any forecasts or opinions expressed herein are Insight Investment's own as of October 31, 2025, and subject to change without notice.