Around the Horn: Fixed Income Roundtable with UBS Asset Management
There is a growing sentiment among fixed income investors that economic resilience will preserve yield levels, influencing currency trajectories. Per the full note from UBS, top portfolio managers highlighted the robustness of the U.S. economy with impressive employment and inflation figures setting the tone for 2024. With these dynamics, market participants should brace for fluctuations as the Fed continues to navigate a complex economic landscape; yields and associated currency pairs remain pivotal metrics to monitor.
What the desk is arguing
The current economic conditions driven by robust employment and inflation metrics suggest continued strength across fixed income markets. Per the full note from UBS, this resilience is expected to keep market participants vigilant as they shield against volatility in yields and price movements.
Additionally, UBS portfolio managers emphasized the necessity for close attention to the evolving landscape of fixed income, suggesting tactical positioning in municipal and corporate bonds might yield advantageous outcomes amid these fluctuations.
Where it sits in our coverage
While our current internal coverage does not highlight specific currency targets, the firms consistently tracking this macroeconomic outlook include firms like jpmorgan with a target of 1.10 for March 26. Our take aligns closely with predictions highlighting the potential for strength in fixed income assets based on current economic indicators.
How other firms see it
Overall, firms aligned with the positive growth sentiment include jpmorgan and others taking a bullish stance on fixed income strategies, while firms like bofa have a more cautious outlook.
Given these perspectives, watch the U.S. Dollar and its corresponding pairs as they respond to Federal Reserve directives and yield fluctuations, particularly how these reflect in the USD/JPY and USD/EUR metrics.
What the calendar says
There are no significant calendar events in the next 30 days that will shape the trajectory for fixed income or FX movements, suggesting a period of steady observation without immediate external catalysts.
01Economic resilience indicated by strong employment and inflation data is expected to influence fixed income markets.
02Portfolio managers emphasize vigilance in yield and price fluctuations as a key focus area.
03No high-impact calendar events are on the horizon, indicating a stable observation period.
04Expect fluctuations in yield-driven currency pairs as market sentiment evolves.
Market implications
Key areas to monitor include the USD/JPY and USD/EUR as they reflect market responses to Fed policies. Traders should remain alert to movements in yields, particularly as central bank communications may signal shifts in monetary policy or economic assessments that could alter positioning.
Risks to this view
A significant shift in economic indicators, particularly an unexpected downturn in employment or inflation data, could significantly alter the market's risk appetite and challenge the current bullish sentiment in fixed income. A change in the Federal Reserve's policy stance, particularly towards easier monetary conditions, might also reverse trends.
ubs
Welcome back to our series around the horn with UBS Asset Management's Fixed Income Team. With that, glad to welcome back this month's featured speakers, top portfolio managers and business heads from Asset Management's Muni Taxable Fixed Income and Liquidity teams. We will hear candidly from them on their views on markets and what they believe you, our financial advisors, should be focused on within the fixed income space.
Joining us for this month, glad to welcome back Anthony Liotti, head of the Fixed Income SMA Advisory Group. Anthony will also serve as our moderator for today. On the panel, we're joined by Dave Walczak, Senior Portfolio Manager for AM's Liquidity Strategies.
Dave Rothweiler, Senior Portfolio Manager for AM's Short Duration and Liquidity Strategies. Dave Vignolo, Head of AM's U.S. Corporate Fixed Income Strategies.
David Michael, Portfolio Manager for Emerging Markets. Patrick Matiewicz, Portfolio Manager for our U.S. Multisector SMA.
As well as Lisa DiPaolo, Senior Municipal Bond Portfolio Manager. So with that, Anthony, I know you'll moderate today's segment for us, so welcome back. Let me pass it over to you.
Yeah, thank you. Happy New Year and happy healthy New Year to everyone. And thank you once again for taking the time and tuning in to the EBS Around the Horn call.
As you heard, we have a great lineup today. So in keeping with form for these calls, I'll address some macro topics and then turn it over to the PM team for their views of the market and how we're positioning across our resolution. So allow me to just take a little bit of a look back on to 24 and we'll get to 25.
I think clearly, you know, the overarching narrative for the year was for the most part underscored by a robust economy that surpassed so many expectations. Both the employment as well as inflation data clearly stood out for their resilience within the marketplace. The fixed income markets notably saw monthly fluctuations in both price and yields, which were influenced by just a number of economic as well as political factors and of course policy decisions.
In going back to December, unfortunately December wasn't the December that so many of us who live within the fixed income world are typically used to. If history were a constant, you know, we would have just seen positive returns across most of the fixed income solutions just simply supported by, you know, seasonal market technicals. But of course 2024 just had to be different.
Year end, fixed income returns across just about every fixed income asset class though were positive. But the negative performance of December clearly needed what would have been a much better year. In looking at the Fed, you know, just rewinding again, the Fed ultimately implemented three cuts throughout the second half of the year and closed with a total of 100 basic points of easing.
I'd say on my particular, you know, thoughts, I think that was a little bit too much, but you know, that's debatable. The last cut, which was in December, the market once again turned, I'd say sharply negative and the Fed signaled, as the Fed signaled, excuse me, that they were going to be a bit more dovish in 2025. And with that, they indicated just two additional reductions in the Fed funds rate over the new year.
Currently, the market has gotten, I'd say, a bit more even hawkish on that and is pricing in about just over one cut for the year. Clearly, as we know, these adjustments and expectations will continue to adjust throughout the year. The adjustment that we saw by the Fed and projections, you know, when you look at that coupled with the uncertainty surrounding, you know, the new administration's implementation for pro-growth, and as we're clearly hearing, what could be pro-inflationary policies clearly factored in to the sell-off, and I'd say it still holds true in today's bond market, as we see yields sharply rise.
I'd say this, you know, a really interesting data point that has many confused, and this kind of dovetails my good friend, who you'll hear from in a minute, shot us a screenshot of this earlier this morning. It was since the first cut by the Fed in September, longer-term yields have risen by more than 100 basis points, right? That is not the norm, but as we sit here today in the second full week of 2025, yields on 30-year bonds are at the highest since 2023, and the yield curve is the steepest since 2020, and if you lived in the UK, boy, yields are at the highest since the great financial crisis.
So yields, not only domestically, but globally, we're seeing increase. 2024, I mean, look, there are some policies, right? As I mentioned, the vast majority of asset classes managed to end the year in positive territory, which did mark back-to-back years of positive returns. When you look at core domestic fixed income classes, depending upon the duration of a solution, the credit quality, items like that, returns varied anywhere from 1% to, let's say, 8% for the high-yield space.
EM also. We hear from David Mike here, EM had another good year. But clearly, we would say that investors were rewarded for a balanced portfolio of fixed income securities.
And turning and looking to 2025 here, this is the first full week of January. Just really quickly, I'd say the firm remains or believes that inflation is still on track to hit 2%. But as we can see, the economy stateside remains on solid footing.
Inflation continues to remain stubborn. Yes, it's drifting lower, but clearly not as much as many expected. And the employment picture, we'll hear more about that at the end of the week, but remains in good shape.
The uncertainties, however, surrounding, again, new policy, the deficit, potential impacts on the economy cannot be overlooked. And that's really what is causing much of the angst in today's market, along with a tremendous amount of just uncertainty. So with that, I will pause there.
And like we have done so many times in the past, I will turn it over to the short-term folks. David Walczak, why don't you lead this off here, sir? Yeah, great.
Thanks, Anthony. So I guess just kind of recapping what we saw here in the front end last year. Anthony, as you mentioned, the Fed ultimately delivered 100 base points worth of cuts in just the last three months of the year.
I think it is important to also point out that around this time last year, the market was actually pricing in 168 base points worth of cuts for last year. So the Fed ultimately delivered less than that. But certainly, there were points last year when the market was pricing in less than 100 base points that the Fed ultimately delivered.
So the point being is clearly there was a lot of change in sentiment over the course of last year in terms of what ultimately the Fed decided to do in terms of easing in the market. Looking ahead this year, as you kind of alluded to, Anthony, the market is only pricing in 40 base points worth of cuts by the end of the year, which takes Fed funds to just over 390. The first meeting with a full 25 base points priced in is actually the June meeting.
So we do have a few meetings here where the market is expecting the Fed to be on hold. And I think that somewhat is understandable given all the uncertainties that we're currently faced with, most notably in terms of what ultimately is going to be put forth from a policy standpoint from the new administration. So I think a lot of uncertainties for the Fed to grapple with.
And as you mentioned as well, I think Fed Chair Powell indicated in their press conference that they'll continue to be data dependent and look to see how things materialize on the policy front. Looking in terms of what we saw from a money market fund flow standpoint over the past year, as measured by the ICI across the entire U.S. money market fund industry, assets ended the year roughly around $6.8 trillion. So that means roughly about $960 billion flowed through during 2024.
And actually a little over half that amount flowed in after the Fed began cutting rates in mid-September. So I think that kind of reinforces what we've mentioned on previous Around the Horns, where it was our sense that we wouldn't necessarily see this groundswell of assets flowing out of money market funds. In fact, we actually saw the opposite occur in terms of cash consuming that come in.
Looking at just the front end of the curve here from a Treasury standpoint, we have seen steepness emerge in our part of the curve. I know there's been obviously a lot of headlines around just the broader yield curve re-steepening, but we're also seeing it here in the very front end as well. Looking at the spread between one and two-year Treasuries, that's now turned positive, sitting at 10 basis points.
It was actually negative 54 basis points as recently as the end of August. So we've seen really since then kind of a steady move steeper in terms of that portion of the curve. The one-month to one-year Treasury curve is still negative at negative 13 bps, but it's deeper than the negative 100 bps that we saw just before the Fed began cutting rates back in September.
Other things that are on the radar for us here in the front end, obviously the debt ceiling is going to be something that we'll be paying pretty close attention to over the first half of this year, although it will be combining the debt ceiling that is this month. As Treasury has done in the past, they'll enact what's called extraordinary measures that basically push off when the X date or the date in which Treasury would run out of cash further off in the future. It's still a little early to pinpoint exactly when that date's going to be, but early indications are at some point around the middle part of this year.
We have been encouraged by signs that it looks like Congress is looking to potentially address that in one of the upcoming reconciliation bills that Congress is looking to put forth maybe as soon as the end of the first quarter, early second quarter. Hopefully, maybe we'll have a little bit of resolution around this and not really come down to the wire, but as we've seen in Washington, really anything's possible. We'll be on the lookout for that.
With that, I think I'll pass it over to Dave Rothbard. Thanks so much, Dave. Again, as Anthony and Dave touched on, since the September 18th FOMC meeting, the Fed has lowered their overnight rate about three times for a total of negative 100 basis points.
At the same time, the longer end sold off for an increase of about 100 basis points. After being inverted for about two years or more, the front end has finally become more normalized, and as Dave mentioned, except for about a 15 basis point dip between three months and one year, the Treasury curve has now lost flat. What does all that mean from a return perspective?
Looking at the B of A zero to one U.S. corporate index, since September 18th at that FOMC meeting, the zero to one has returned a positive 140 basis points. Generically, the front end has outperformed given the curve moves over the past quarter with no real indication the Fed is increasing rates anytime soon. Delta short and short duration strategies offer an attractive place to pick up incremental yield.
Moving on to credit, similar story again. The corporate credit curve in the front end is pretty flat. Looking at the Bloomberg U.S. corporate indices during 2024, the option adjustments spread between the zero to three and the three to five year index, hit a high of 34 basis points back in March.
Then as the year progressed, it hit a low of 11 in December and now sits about three basis points off that, about 14 or 15 basis points. So the credit curves have become extremely flat in the front end. So again, with that being said, looking at the ultra short strategy, we've continued to focus on the six-month to 18-month part of the curve, and then the short duration one to threes, we try to favor the two-year area when possible.
Staying with credit, overall employment as well as economic growth have been decent, which supports risk assets. As a result, the new issue corporate market continues to be pretty robust. Some estimates for corporate new issuance for the month of January were around $175 billion.
This is only roughly the fifth business day of the month, and we've already hit $75 billion in new issuance deals, with an average of 3.3 times being oversubscribed, and new issue concessions averaging about 2.8 basis points, which is still a healthy market. While overall credit has been resilient in the front end, there have been some pockets of some spread widening and some industrial names trading maybe 10 wide to where they were just a couple of months back, which is, at this level, it becomes more in line with ADS spreads. At this point, right now, it's been a nice opportunity to add A and AA-rated industrials when possible.
With that, I'll pass it on to David Doehm. Thanks, David. On the investment grade side of the ledger, 2024, just briefly, was a real strong year.
Total returns from excess return and absolute total returns were positive. Strong corporate fundamentals as economic growth was quite resilient, and the technicals just came in probably just under $400 billion for inflows into the asset class in 2024. That was, as I mentioned, driven by the positive economic growth, but I think, more importantly, probably the most predominant driver was the attractive L&E yields for investment-gated corporate bonds that we haven't seen in close to two decades.
That was really the impetus to strong demand and a very high degree of comfort for the asset class from a fundamental and technical perspective, but I will say that as we start 2025, we're a little more on a cautionary note, I'd say, to start the year. It doesn't change the fact that the fundamentals are still good and technicals are robust, but I think we're expecting a lot of supply this month of about $150 to $180 billion. Then when you throw on top, as Anthony said, the macro volatility that we've seen in the treasury market with yields going up dramatically since the Fed first raised interest rates, and I saw it as of December 1, and the 10-year is up about 50 basis points from that point, so we're talking basically six weeks.
We have a lot of people who are a little more cautious to start the year and kind of waiting on the sidelines, but I think as things start to subside, things will resume once again with strong demand for the asset class as economic growth remains roughly 2%. Some of the things, as President Trump takes office on GN20, some of the things that we're thinking about on our investment-grade strategies is that from a sector perspective, we're definitely a little more cautious on the auto and retail sectors because of concerns about potential tariffs, and then on the managed healthcare and the pharma sector, we think there's an increased likelihood of more regulatory oversight from the Trump administration, so we're concerned about that as well as probably we're going to see increased M&A risk in those two sectors, which will definitely present opportunities for us as investors, for our clients in those sectors, but we're being cautious ahead of that because we think there'll be some better entry points as that starts to unfold. And I would say on the positive side for the sectors, the financial sector, the energy sector, and utility sectors are three sectors we favor and have overweights in, and we think those sectors will benefit as well from a less restrictive regulatory environment when the Trump administration takes office.
So that's how we're kind of starting the year from a sector perspective, but I will say that in general, with this backup in yields in the treasury market that we've seen, that's pushed our all-in yields for the corporate market up into the mid to low fives, so we're starting to get some very attractive levels from a historical perspective, and I would expect as things start to settle down, maybe toward the end of this month or into February, renewed demand, as I mentioned earlier, back into the space for investors looking to lock in these yields for a longer-term perspective. And then finally, just overall duration, we're definitely leaning, we're neutral to a little bit underweight for active intermediate strategy, and we're looking to probably extend a little bit down the road from that standpoint when things, as I said, start to settle down, because I think the view of a 10-year treasury yield close to 5% seems historically to be an attractive entry point in that range, so we're looking to possibly adding more exposure from a duration perspective for our strategies if we start to see that occur. And then finally, from a bottom-up perspective, we're looking to add more high-yield exposure into our active intermediate strategy and add more exposure there in the front of the curve as the economy continues to remain quite resilient.
So those are some of the things we're looking at to start the year, but it's definitely, as David Walczak said, it's going to evolve quickly in a lot of moving parts, but I think there's going to be definitely more, I'd say the theme in 2025 is going to be more opportunities, more volatility, and being more tactical in moving around in sector weightings and duration weightings and position exposure as we move through the year. So I'll stop there and pass it on to David Michael to talk about the emerging market strategy. Thanks, David.
Overall risk tone in emerging markets continues to be set by U.S. rates and uncertainty around President Trump's second term. Emerging market spreads heightened by 22 basis points over the last month of the year. That wasn't enough to offset the Treasury widening of 50 basis points, and this left emerging market total returns in negative territory for December.
In 2024, EM credit spreads heightened for the year by 60 basis points, while U.S. Treasury widened by about 70 basis points, and that provided emerging market indexes with total returns anywhere from 6 to 7.5%. EM high yield was the largest outperformer where we saw another year of double-digit returns.
That's the second year of double-digit returns in a row. EM debt supply remained really subdued over the last quarter of the year. This left EM with net negative supply of close to $100 billion on the year.
This is a very positive technical for the asset class in 2024, and we expect this to continue to support emerging markets into 2025 as investors are receiving more cash from coupons and maturities and less availability of new bonds to put that money to work. Further, emerging markets has been attracting more crossover, non-dedicated flows into the higher quality parts of the asset class. While if you look at the retail flow numbers, they continue to reflect outflows from the asset class, but this only captures less than 10% of the emerging market asset class.
It doesn't capture the previously mentioned crossover and the institutional inflows, which are much larger into the asset class. As we look to 2025, we expect another strong year of returns, similar to 2024, but with more contribution from U.S. Treasuries, and all-in yields in emerging market credit remains very attractive.
We see positive tail risks that can emerge over the coming year, especially if geopolitical tensions ease and there are ceasefires negotiated. This would continue to be positive for emerging market risk. The consensus on Trump policy implications on inflation and dollar strength may be challenged, but as my colleague mentioned earlier, we will continue to see volatility around this, and this underpins the importance of having active managers, not only for fixed income, but emerging market risk.
In this environment, we believe these idiosyncratic risks and stories are likely to perform well, especially in 2025. Now let me hand it off to Patrick for an update from our multi-sector team. Of course.
Thanks, David. From our end, little change on rates or credit positioning or thinking from the multi-sector desk, that is, over the last month. In rates, we remain neutral to target duration across our book of business.
You might call it a patient posture, just waiting for market cross-currents to begin to come into better view here early in the year. General thinking near-term, absent some material new information, is that we're likely range-bound on rates, so think 420 to 5% or so in the 10-year, as David Vignolo mentioned earlier, from an upside standpoint. 470, about where we are now, is a level of interest on the 10-year that we've tested, and we failed to breach last April. So quite keen to observe the drama of this week as more of the labor data unfolds and what happens as related to rates.
No big changes in credit either. We remain constructive, as noted last month. Fundamentals still strongly supportive.
Of course, the economy and earnings, high all-in yields are likely to keep drawing demand on the technical side. So we're content to generally be long here credit for these reasons laid out, again, across our book of business and inappropriate portfolios. Sector-wise, we continue to reap the rewards of somewhat more striking or interesting exposures that we pair with the sectors my colleagues on this call specialize in, and this would include perpetual preferred securities.
These are predominantly from the systemically important U.S. banks, to a lesser extent a couple of utility issuers in terms of our allocation, generally boasting quite conservative balance sheets. They're quite highly regulated. And in a sense, that is what better justifies owning the subordination risk inherent in them.
The preferreds we own in our shared client portfolios, they all boast QDI, or Qualified Dividend Income. That exacerbates the attractiveness of the tax-equivalent yields they afford investors who are in the higher income tax brackets. And what's more, we're biased to fixed-to-float variable rate preferreds, the larger portion of this market.
These have fared quite well in recent months, as you might imagine, owing to the rate defensiveness characteristics, but they still capture that compression component of pay for subordination, which is generally lessened in a year where credit was well-rewarded. We've also gravitated to higher coupon, higher all-in implied resets. That further affords rate defensiveness and basically isolates the decision to be in preferreds to more of a credit versus a credit end duration or credit end rates type exposure and allows for greater duration and spread duration spend elsewhere in our portfolios.
Variable rate preferreds comprise about 8% of the multi-sector bond SMA portfolio, all told. With that, I'll turn to Lisa DiPaolo on TaxExempt Municipal. Thanks, Patrick.
As Anthony indicated earlier, the municipal market experienced some pressure at year-end, ending with one of the year's worst monthly returns. December was marked by a volatile treasury market and more hawkish than expected Fed tone at their final meeting in 2024. So despite the volatility we saw that occurred in 2024, muni-treasury ratios never really became overly bearish.
We finished the month of December higher with the exception of that 30-year ratio. And in terms of just outflows, we did see persistent new outflows within the asset class in December. Looking back, we ended the year with 43 weeks of inflows and nine weeks of outflows.
So when we saw these muni funds and ETFs outflows for the first time really, liquidity did start to dry up more mid-month and we did see munis start to underperform during this period. I would say, though, however, despite these outflows through the month, they were offset by an environment of very active tax loss harvesting that required immediate reinvestment. Supply was robust to start the month of December.
We did start with one of the larger weeks of primary supply issuance, $13 billion beginning of the month. But overall issuance in December totaled $35 billion, so it was a slight increase over the prior year. So just kind of given the strong demand, we saw more from retail and institutional investors, and then just overall the elevated demand, it did cause prices to naturally rise.
And we ended the year in 24 with total tax exempt and taxable issuance increasing to a record $504 billion, $463 billion of that being tax exempt. So it was up 37% year over year, so another record year. And I would say sectors including higher education, healthcare experience, and uptick in supply just following project delays in previous years.
So looking ahead in 2025, the January effect, really lower month of lower supply and seasonally strong January 1st reinvestment dollars is in full force. Projections for 2025 suggest another heavier year of issuance as well will persist. The street right now is forecasting anywhere from $480 billion to a high I saw of $745 billion in issuance.
A lot of that is just continued infrastructure needs by issuers and current refunding volumes, which is adding really just to the supply. But issuance could be impacted if potential tax policy changes impact the status of taxes and bonds and how issuers react to that. We'll have to see.
Looking ahead, I'd say 2025, expecting to bring ongoing rate volatility. The Fed continues to cut rates in 2025. We could expect to see a steeper yield curve, might see more of a demand for longer duration bonds.
I do expect elevated muni yields will attract investors, but as we know, monetary and fiscal policies could impact overall demand. Although we would expect more positive tone for the muni asset class in 2025. As we know, again, several factors including uncertainty around new administration, changes in fiscal tax policies, a push to extend several key provisions of the Tax Cuts and Job Act, tariffs, proposed immigration policies, all this could impact the market and will be closely monitored on our end.
And just looking ahead at our credit opinions in 2025, we do believe municipal credit quality remains stable, just driven by a strong national economy, a softer but stable labor market, robust consumer spending. We do believe state and local governments are well positioned to weather a downturn just due to strong reserves they've accumulated over the past four years. As of fiscal year 2024, state rainy day funds stand at $156 billion, which equals 13% of spending, and that is a record high.
So as revenues normalize from post-pandemic highs, we expect to see pockets of credit stress in that single A and triple B rating categories. So consequently, we would recommend going up in credit quality at a time when credit spreads are all-time tight and threats to muni credits are not fully priced in, just due to various factors. In terms of our overall positioning across our strategies, we haven't really made any big adjustments coming into the new year.
We continue to remain aggressive in sourcing buying opportunities in the market with these higher yields, as we also in December continue to anticipate increased reinvestment pressures, so more or less fighting cash. As we've seen some more normalization in the yield curve and less inversion, we've lightened up a bit, being so heavily barbelled in some of our portfolios, continuing to actively reduce our exposure in BRDNs in favor of some shorter maturities, along with more favorable spots in the curve, including that 15- and 25-year bucket. So we are looking to potentially make some more changes or adjustments in positioning as we move past this month and gain more information in the market.
With that, I will turn it back over to Anthony. With that, we are a bit over time. I apologize for the little bit longer, but it is a new year call, so we're going to be a little bit more long-winded here with a bit more information.
I appreciate your patience. Thanks again for tuning in, and we look forward to talking to you next month. As a firm providing wealth management services to clients, UBS Financial Services, Inc. offers investment advisory services in its capacity as an SEC-registered investment advisor and brokerage services in its capacity as an SEC-registered broker dealer.
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