Labor market strength drives Treasury yields higher

Weekly fixed income update highlights

• Preferreds, high yield corporates, senior loans and emerging markets all had positive total returns.
• Treasuries, MBS, investment grade corporates, ABS and taxable munis all had negative total returns.
• Municipal bond yields ended the week mixed. New issue supply was $19B, and fund inflows were $426M. This week's new issuance is expected to be $14.3B.

U.S. Treasury yields climbed last week as robust U.S. employment data outweighed mixed economic signals, with the May jobs report showing stronger-than-expected gains despite earlier private sector weakness.

Watchlist

• Treasury yields moved higher, and we continue to expect elevated volatility, a wider trading band and a modest rally from current levels.
• Spread sectors gained substantially versus Treasuries as labor market data were stronger than feared.
• We expect the technical environment for municipal bonds to improve as the year progresses.

Investment views

We believe fixed income yields generally present one of the best entry points in a generation, creating attractive income opportunities.

Downside economic risks are material, despite strong fundamentals, with tariffs likely to compress consumer spending and weigh on business fixed investment. A U.S. recession is not our base case.

Risk premiums may widen further, with entry points likely to become more attractive over the coming quarters. Duration is likely to reassume its role as a growth hedge.

Key risks

• Tariffs further undermine consumer and business confidence, raising prices while weighing on sentiment and activity.
• Inflation fails to continue moderating as expected, weighing on asset prices.
• Geopolitical flare-ups intensify around the world.

Preferred securities start June on strong footing

U.S. Treasury yields moved higher last week after stronger labor market data. The 10-year Treasury yield ended 11 basis points (bps) higher, with all of the move coming after Friday's nonfarm payrolls report for May. The data showed a 139,000 net gain in employment last month, with the unemployment rate flat at 4.2%. The strong headline reading was offset somewhat by downward revisions of 92,000 to prior months, but it still beat consensus expectations. Those forecasts were marked down earlier in the week after a private sector gauge of employment growth surprised substantially to the downside, showing only 39,000 jobs gained last month. Additionally, surveys of business sentiment showed a further deterioration. Nevertheless, the official nonfarm payrolls report remains the single best indicator of economic health, and its strength more than offset any weakness from the other datapoints.

Investment grade corporates retreated alongside the increase in rates, returning -0.23% for the week. Nevertheless, spreads tightened 3 bps and the asset class outperformed similar-duration Treasuries by 28 bps. Preferred securities returned 0.44% and beat similar-duration Treasuries by 92 bps, placing them on strong footing to start June. Across investment grade markets, supply was close to expectations, totaling $26 billion. Those deals continued to be well-digested, with average oversubscription rates of 4x and new issue concessions of 1.3 bps. Inflows picked up at $4.9 billion.

High yield corporates notched another weekly gain, returning 0.32% and beating similar-duration Treasuries by 63 bps. Senior loans returned 0.14%. Inflows were especially strong into high yield funds, totaling $1.5 billion, while loan funds saw a more modest inflow of $45 million. Both asset classes had healthy supply, totaling $11.6 billion and $8.7 billion across high yield and senior loans, respectively.

Emerging markets outperformed, returning 0.21% and outpacing similar-duration Treasuries by 68 bps. So far in 2025, emerging markets as an asset class has outperformed Treasuries by 112 bps, making it the best-performing asset class so far this year. Inflows picked up materially, totaling $721 million, while supply was also slightly higher at $8 billion.

Municipal bond supply remains challenging

Municipal bond yields were mixed last week, and the yield curve performed surprisingly well given outsized new issuance. Short-term yields declined -7 bps and long yields finished 4 bps higher. New issue supply was surprisingly well received. Fund flows were positive overall, while exchange-traded fund outflows totaled -$145 million. This week's new issuance is expected to be the fourth largest ever and should be well received.

Muni market supply and demand remain in equilibrium. The market saw the second largest issuance ever last week at $19 billion. It was absorbed mainly due to the $140 billion of reinvestment money that is beginning to enter the system from June to August. Supply should be challenging again this week, but the reinvestment money should provide support. Also, intermediate tax-exempt bonds yielding 4% and longer bonds at 5% continue to pique institutional and individual investor interest. Look for outsized new issuance to continue through the summer as issuers take advantage of the outsized reinvestment money.

Board of Regents of the University of Texas System issued $692 million revenue bonds (rated Aaa/AAA). Some bonds traded in the secondary market at a premium to where they were issued. For example, 5% coupon bonds due in 2036 were issued at a 3.72% yield and traded in the secondary market at 3.62%.

High yield municipal yields ended the week slightly higher, showing steadiness amid heavier supply. New issue deals were firmly subscribed. Secondary market volumes declined as available cash flow gravitated toward higher absolute yields.

High yield corporates saw especially strong inflows, along with healthy supply.

In focus: The ECB cuts and prepares to pause

As expected, the European Central Bank reduced its benchmark deposit rate by 25 basis points, to 2.00% - its eighth consecutive rate reduction during this easing cycle, which began a year ago.

The ECB's economic forecasts were little changed from March. Inflation, currently 1.9%, is expected to edge up to 2% by year-end, while annualized GDP growth is anticipated to remain at 0.9%. ECB President Christine Lagarde noted that if trade tensions "were resolved with a benign outcome, growth and, to a lesser extent, inflation, would be higher" (and vice versa). These projections assume a 10% flat tariff from the U.S. and no retaliation by the European Union, and they align with ours.

Lagarde also made clear that "We are not committing to a particular rate path" and "especially in current conditions," the ECB "will follow a data-driven and meeting-by-meeting approach" to monetary policy. At the same time, she noted the ECB is "in a good position," suggesting a pause in cutting rates is forthcoming, which is what we expect.

That is because Germany, Europe's largest economy, is primed to launch a massive stimulus program focusing on defense, infrastructure, cybersecurity and green energy. Remaining patient will allow policymakers to assess the program's impact. In our view, this shift from decades of fiscal austerity warrants higher yields, a stronger euro and structural support for European assets more broadly through the medium-term.