Today’s Fixed Income Challenges and Opportunities

As fixed income investors reassess their portfolio allocations, Erin Spalsbury, Head of Investment Grade at Insight Investment highlights her expectations both near-term and into 2027:

• Volatility likely to remain elevated given the number of macro uncertainties 
• Federal Reserve expected to remain on hold near term, with potential cuts later in the year or into 2027 dependent upon the impact and duration of high energy prices
• Higher-for-longer rates supportive of intermediate fixed income overall, with selection and risk management particularly important in this uncertain environment. 

Transcript

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Welcome to the Access to Alpha podcast series from Advisors Asset Management, where we provide exclusive market insights and timely commentary from our portfolio managers and strategic partners. AAM has been committed to delivering innovative, research-driven solutions that help investors navigate complex markets and build more resilient portfolios. We invite you to hear these insights now. Hello, my name is Aaron Spawsberry with Insight Investment. It is May 21st, 2026, and I'm pleased to join you on the AAM Access to Alpha Podcast. Welcome to our first quarter market update. In the next few minutes, I'll walk through what happened in the U.S. economy, how we positioned the portfolio against that backdrop, and I'll go over our current outlook. It was a quarter shaped by cross currents. The inflation improved, but then geopolitical tensions added a fresh source of uncertainty for markets. Starting with the economy, the data was mixed. Payroll numbers were uneven, with a very strong January followed by a weaker February, which reinforced the idea that the labor market is no longer moving in a straight line. Inflation, however, continued to move in a better direction. Headline inflation fell to 2.4%, while core inflation moved down to 2.5%, the lowest level we've seen in nearly five years. At the same time, growth lost some momentum, with GDP expanding just 0.7% annualized pace in the final quarter of 25%, down sharply from 4.4% in the prior quarter. Consumer confidence also reflected a more cautious tone. After improving early in the quarter, sentiment fell back again and remained close to very weak levels seen late last year. Rising concerns around the conflict with Iran and the effect on gas prices and broader markets weighed on confidence. Manufacturing data held up better with the ISOM index staying above 52 and ahead of expectations, although that reading was collected before the conflict escalated. So as we move into the next quarter, investors are watching closely to see whether higher energy prices begin to feed through more meaningfully into activity and inflation. Against that backdrop, the Federal Reserve left interest rates unchanged at 3.5% to 3.75%, which was widely expected, but the policy outlook became more complicated as the quarter went on. Earlier in the period, markets were focused on the possibility of lower rates as inflation eased. By quarter end, that conversation had shifted, with investors asking whether a renewed rise in inflation could keep rates higher for longer or even force the Fed to consider a different path if price pressures became more persistent. Government bonds as a result were volatile over the quarter, and that volatility picked up sharply in March. As energy prices rose, investors became less confident that inflation would keep falling smoothly. In the US, the ten year treasury rose 15 basis points to a 432. Similar moves were seen in Germany, while yields rose more meaningfully in countries such as Italy, the UK, Japan, and Australia. Emerging market bonds yields also moved higher, and in simple terms, markets adjusted to a world where inflation risk may be more persistent than hoped, especially if energy prices remain elevated. Now credit markets faced pressure as well. Spreads widened from the very tight levels we saw recently, and because government bonds yields also rose, an all-in-corporate bond yield moved higher still. In investment grade credit, spreads on the Bloomberg U.S. corporate index ended the quarter eleven basis points wider at 89 basis points, while the broader Bloomberg U.S. credit index widened 10 basis points to 83. Europe and the UK also saw wider spreads, and the move was even more pronounced in high yield, where investors demanded meaningfully more compensation for risk. Overall, this was not disorderly sell-off, but it was a reminder that markets had entered the year from a relatively rich valuation, leaving less room for disappointment when the macro backdrop became more uncertain. For performance, the Bloomberg U.S. Investment Grade Corporate Index delivered excess returns of 49 basis points in the quarter, while the Bloomberg U.S. Credit Index returned to negative 44 basis points on the same basis. Sector performance was mixed. Energy related areas such as independent energy refining and oil field services were among the stronger performers naturally, benefiting from the move higher in oil prices. More defensive areas, like noncyclical consumer products, also held up relatively well. Now turning to the outlook, the conflict in the Middle East has added meaningfully new risk to the path for both growth and inflation. Our base case is for US GDP growth of 2% in 26 and 1.9% in 27%, with inflation peaking at 3.1% this year before moderating to 2.5% next year. That said, the range of possible outcomes is wider than usual. In the near term, higher energy prices are likely to delay any Fed cuts from the Federal Reserve, but if those prices begin to weigh more heavily on activity and the labor market, the case for policy support later in 26 could strengthen. Much will depend on how long the oil supply disruption persists because monetary policy is not especially effective at offsetting the stagflationary effects of an energy shock. For now, U.S. growth has remained reasonably resilient, supported by ongoing AI related capital spending and a consumer backdrop that has so far held up better than many expected. Our current view is that the Fed is likely to stay on hold for the time being, with cuts more likely later in the year or into 2027. Over the next twelve months, we expect Fed funds rates to be around three and a half with 10 and 30 year yields eventually falling. Even so, we would expect volatility to remain elevated given the number of moving parts in the macro backdrop and with the midterm elections approaching. As always, we remain focused on staying selective, managing risk carefully, and looking for opportunities where valuations better compensate investors for uncertainty. And quite frankly, we're heartened with the higher yields at this point with the opportunity to invest in yields higher than 6%. Thank you for joining us on this edition of AAM's Access to Alpha. For more information, please reach out to a financial professional or visit our website at AAMLive.com.