CIO Fixed Income Roundtable Podcast Series
The FX desk interprets the recent commentary from UBS' Fixed Income Roundtable as suggesting a tightening of monetary policy amidst strengthening economic indicators. This assessment comes directly after the Fed's unanimous decision to raise interest rates by 25 basis points following their September meeting. Per the full note from UBS, the Federal Reserve, led by Chairman Walsh, cited stronger-than-expected growth, bolstered by improvements in hiring and private sector earnings, as a critical driver behind this adjustment. The overarching theme is one of cautious optimism, but with marked attention given to the progress on inflation, which remains lackluster according to Walsh's indicators, creating possible volatility in fixed income markets and, by extension, currency pairs influenced by U.S. monetary policy.
What the desk is arguing
The desk posits that improved performance in the U.S. economy is beginning to shape the trajectory of interest rates, suggesting a potential firming of the dollar as monetary policy leans towards the hawkish side. Notable are the remarks about robust credit flows and ongoing business investments, which enhance the outlook for taxable fixed income markets, as noted in the UBS commentary.
Moreover, Walsh highlighted three key influences on the Fed's decision-making, with stronger-than-expected growth being pivotal. Without substantial progress on inflation, market participants may need to brace for future increases or prolonged high rates, exacerbating volatility in asset classes including fixed income.
Where it sits in our coverage
As it stands, our consensus target for USD performance is pegged at 1.075 against the EUR, with a range likely to oscillate between 1.04 and 1.12. Specific institutional forecasts include: - jpmorgan: Target of 1.10 for Mar-26 - bofa: Target of 1.04 for Mar-26
This view aligns fairly closely with jpmorgan, which sets its target on the higher side of our spread, while bofa presents a markedly lower outlook. The positioning indicates that the desk's thesis is seated comfortably within the prevalent market consensus.
How other firms see it
Most analysts appear to echo a cautiously optimistic outlook on U.S. economic data, aligning with jpmorgan that expects the dollar to strengthen in light of recent Fed actions. In contrast, firms like bofa reflect a more bearish sentiment, calling for a weaker dollar based on their inflation outlook.
Market watchers might consider the interplay between the EUR/USD and factors such as upcoming U.S. Non-Farm Payrolls or inflation reports, which could induce volatility in currency markets, amplifying responses to Fed communications and economic data releases.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The Fed raised rates by 25 bps, emphasizing strong U.S. economic data.
- 02Robust private sector earnings and credit flows remain critical indicators.
- 03Lack of inflation progress may lead to market volatility amid tightening policies.
- 04Institutional targets reflect a consensus bullish outlook for USD strength.
Market implications
Traders should monitor reactions in the EUR/USD pair ahead of any inflation data, specifically readings that could indicate whether the Fed's tightening narrative gains more traction. A sustained break above 1.075 could signal further bullish sentiment towards the dollar.
Risks to this view
A rapid deterioration in employment figures or unexpected inflation spikes could lead to a reevaluation of rate hike expectations, reversing current positioning towards the dollar. If inflation shows unexpectedly strong signs, policy adjustments might become more aggressive.
Hi everyone, Dan Cassidy here. Welcome back to the UBS Market Moves podcast channel. For today, we are going to continue with the Fixed Income Roundtable series with the UBS Chief Investment Office, a performance update and outlook across fixed income subsectors.
Joining us for today's roundtable, glad to welcome back Frank Saleo, Letty Zamedis, Sadiq Murkherjee, Barry McElindan and Sangeeta Marfadia. Hosting our roundtable, we have Head of Taxable Fixed Income Strategy for the Americas from the UBS Chief Investment Office within UBS FSI, Leslie Falconeo. So Leslie, let me now turn it over to you to lead today's conversation with the team.
Welcome back. Thank you, Dan. I appreciate that.
I mean, today is going to be a great conversation in my opinion. I mean, every time we have these bimonthly calls, it happens to be during a time when there is, you know, increased volatility. Today's call is no different.
We just finished the September FOMC meeting and as we all know by now, the Fed raised the federal funds rate 25 basis points from 375 to 4. It's the first hike since July 2023. And it was a unanimous vote, you know, 12 to 0.
And one of the things that Walsh really sort of honed in on, which was different than his, you know, July FOMC, is that he sort of listed out three drivers of what he's seeing. And one of them being, you know, first off, is stronger than expected growth. He repeatedly said the American economy appears to be strengthening, you know, he's setting improvement in hiring, private sector earnings, business capital investment, and obviously, you know, fairly robust credit flows, just given the fact that the capital markets are open and financial conditions, while tightening up the past couple weeks, still remain loose.
The second was an insufficient progress on inflation. Now, as we all know, Walsh is not one to hone in on those inflation indicators, which makes it a little bit more difficult for us fixed income investors to know really what indicator we should be looking at. He keeps that a little vague, but he continuously says that inflation is too high and has been too high for too long.
And he also pointed out a third reason, which is the geopolitical and energy. Now, we know that the continued crisis in the Middle East has heightened and increased energy and oil prices. We have diesel above 6 percent.
We have commodity oil prices just in the first couple weeks of September, returning almost 15 percent. All of this is contributing to potential higher future inflation. But even with that said, when we looked at how the market reaction was, in our opinion, and not just from the FOMC yesterday, but even from the Jackson Hole meeting through yesterday, for example, since, like, the day before his Jackson Hole speech, which the market viewed as hawkish, right, I have two-year yields up 50 basis points, I have a 10-year yield up 35 basis points, and that's just since, you know, August 27th, 28th, so that's about three weeks.
You know, year-to-date, as we know, we've got a very large rise in the short end as we move from cuts to hikes, the two-years up 126 basis points, the 10-years up about 85 basis points year-to-date. And still, we still have this, you know, strong economy. We still have, you know, a solid equity market.
While we're seeing these small pockets of correction overall as wars dictated, the economy appears to be going strong. So, one of the things that the market did after his hike, you know, which it expected, the Q&A was a bit more hawkish than expected, and as a result, the market prices in, you know, about three, close to four more hikes from where we stand today, so when we look at that forward or that terminal rate, you're sitting at about a 472, which is even higher than we were during the hiking cycle of 2022. So what I want to talk about now and really address to our expertise is some of the decisions that we've made over the past week or two, and frankly, our strategy as we reach that 5% in 10-year treasury yield is to add on incremental interest rate risk.
We've been mostly concentrating that short end. We've been patient. We've waited for that 5%.
We've added to our interest rate risk, moving out more to the intermediate or a little further part of the curve. We've recently added to $25 preferreds to invest in great corporates, and we're going to have some of our sector specialists particularly address those topics, which is a great lead off to Frank Saleo, who has our preferred sector, and Frank, you know, you and I have had many conversations about preferreds this year. I know, how do you see sort of the Fed movement yesterday changing performance going forward regardless of preferreds if it does, and what do you think the performance looks like, say, over the next quarter of the year end and even to the first quarter of 2027?
Yeah, thanks, Leslie. Yeah, you know, you mentioned the Fed in particular has really been a driver of change in the market sentiment over the past several weeks. You know, as a matter of fact, thinking back to our last fixed income roundtable in July, so much has changed.
It's just two months later, but it's really a stark contrast to what we were discussing just two months ago. You know, at mid-year, preferreds, just to put some context around this, at mid-year preferreds had a year-to-date gain of about 1% overall for the sector, and then if we look at the two subsectors, that reflected a 2.3% gain to $1,000 par preferreds, but a marginal loss for $25 par preferreds, and at the time, the outlook was beginning to improve for retail preferreds for two reasons. First, it was a possible mean reversion setup in the wake of that performance divergence, and secondly, the possibility of rates trending lower.
In fact, the title of my July preferred securities top picks report was, Cooler Oil Prices Could Heat Up Preferreds This Summer, and I was basically just making the point that lower oil prices could contribute to lower rates, which would then drive preferred sector performance. Now, obviously, over the past several weeks, Treasury rates have surged. The move in oil prices was a key driver of that.
Oil prices rebounded sharply from the June lows after the MOU was announced, but then basically fell apart in the weeks subsequent to that in early July, and in addition to the Middle East conflict driving oil prices higher, the market dramatically repriced Fed expectations, particularly following the worst speech at Jackson Hole, as you mentioned, Leslie. Of course, we did finally get a hike from the Fed at the latest FOMC meeting. As a result of all of this, the performance divergence between $25 par preferreds and $1,000 par preferreds has just grown even further.
As of mid-September, $1,000 par preferreds have a year-to-date gain of about 1.5%, while $25 par preferreds have a 3.5% loss, and that brings up some very important points about these two subsectors of the preferred space. First, it highlights the portfolio value and the resilience and the importance of the $1,000 par sector. $1,000 par preferreds have coupons that are variable rates, so they have relatively lower duration compared to other fixed income sectors more broadly, yet they still offer attractive yields of about 6.5%. That combination of high yield and low duration, it adds resiliency to your fixed income allocation.
Given the moving rates this summer, most fixed income sectors are posting marginal losses for the year 2026, but $1,000 par preferreds are holding on to those gains, again, of about 1.5%. In fact, if you look cumulatively over the past five years, if you look at the cumulative five-year total return for most fixed income sectors through mid-September, what you find, surprisingly, is that the five-year return for most sectors is just mid-single digits at best. In many sectors, for example, if you look at investment-grade corporates or mortgage-backed securities, they're actually posting five-year cumulative losses on a five-year total return basis, but over that same period, $1,000 par preferreds are up over 18%, so it is a very important component to a fixed income allocation.
Now, that's not to say the $25 par preferreds should be avoided. Actually, it's quite the contrary. In fact, with yields around 7%, retail preferreds currently offer better relative value compared to other sectors.
They offer a higher yield advantage relative to $1,000 par preferreds versus historical trends. They also offer a pretty decent attractive yield advantage over investment-grade corporates, and they're now offering a more competitive yield relative to high yield or a smaller yield disadvantage than they have historically, than that's historically been relative to high yield. So, as a result, as you mentioned, we recently upgraded our view on preferreds, specifically the $25 par preferred sector to attractive, and it's just, again, given the extent of the continued performance divergence this year, we could see a mean reverting rebound for $25 par preferreds, especially as treasury rates stabilize and trend lower here.
Remember, those are mostly perpetual preferreds with fixed coupons, so the retail preferred sector is, as you mentioned, Leslie, a long-duration sector, so it's a way to amp up that interest rate beta, so to speak. And so our more attractive view on the $25 par preferred sector does reflect our stronger conviction that we're close to the end of this recent move in rates, closer to the end of this sort of repricing and adjustment to a large extent that's kind of running its course now. And listen, we don't necessarily need to see rates go lower from here for retail preferreds to perform well.
Given where yields are, currently, again, around 7%, that level of carry from a total return perspective represents a significant head start for solid returns. So overall, Leslie, I would advise our financial advisors and clients to check out the latest Preferred Securities Top Pitch Report for specific recommendations among both $25 par preferreds and $1,000 par preferreds, and I'll turn it back over to you. Thank you.
Yeah. Thank you, Frank. And I think one of the really important things that you emphasize, and I'm completely behind you on this, and we've been emphasizing this as well, it's impossible to call the absolute top and tender treasury yields, right?
There's so much uncertainty going on in terms of the Middle East. You might have a heightened conflict for short term, oil might surge higher, but one of the things that I believe as well, which is why we like this sector, we like adding interest rate risk here, is that that compound income that you're earning just offers an incredible amount of buffer to potential price depreciation that you might have if, in fact, yields go up. And again, we can't guarantee that we've seen the top, but one thing that we do believe is that if, in fact, we retire rates, we don't think it's going to be sustainable, and more importantly, Frank, as you'd mentioned, that compounding income is going to be the real tailwind to total return.
So with that said, you know, Sangeeta, I want to turn it over to you because I know that you've made some great sector changes, and if you could just give us an update more on the closed-end side. Thank you. Sure.
Leslie, thank you. So based on Frank's comments and our upgrade of the underlying preferred sector itself, I wanted to highlight some of the funds that we cover, why we see value in closed-end funds investing in preferreds particularly. Now, Frank mentioned preferreds pay roughly 7%.
If you look at the closed-end funds that invest in preferred securities, and because they use leverage, they are, in fact, paying almost 9.5% on average. Yes, there's definitely risk involved because of the use of leverage. Funds tend to trade down fairly quickly when 10-year treasury yields are going up and markets are volatile.
However, these rising rates don't impact the borrowing costs the funds have in terms of their leverage because funds will use some fixed-rate leverage. Therefore, we feel that the distributions paid out by preferred funds tend to be a lot more stable and not get as much negative impact from rising rates. Now, we cover several Conan Steele funds, John Hancock funds.
They're all trading at discounts, and these discounts, when you look at 52-week or two-year average, they are cheapest at this point. We also like these preferred funds because of the tax advantage income they throw out. Significant portion of the distribution that closed-end funds pay out is taxed as qualified dividend income or QDI.
You may have heard them referred to as QDI distribution, and this distribution is taxed at a lower rate than ordinary income, so these definitely make sense for people who are in the higher income tax bracket. I would like to just point out, refer to our closed-end fund coverage universe for specific fund names that we cover that we like or contact your financial advisor at UBS for specific fund ideas. With that, I can turn it back to you, Leslie.
Thanks, Saket. I really appreciate it. You and Frank do a great job in terms of coverage, so I appreciate that.
I want to just shift. While we're talking about credit, I do want to shift over to the high-yield side. Even Chair Warsh kind of referenced the markets are accommodated, financial conditions are loose, and we have this still sort of robust credit flows because even if it's not just the equity market, believe it or not, that's doing well, spreads in terms of fixed income and fixed-income credit has also remained quite stable.
So, Lydia, I wanted to turn it over to you in terms of how you're seeing or what your views are on the credit side and specifically high-yield. Thank you, Leslie, and good afternoon, UBS. So, since our last roundtable call, we have changed our view in high-yield.
We changed from neutral to attractive, and the main reason we did this is because we see a much cheaper entry now. If we look at the three-year Treasury, which aligns with the duration that high-yield has, three years, it has gone up 120 basis points. So, it started the year 3.5, and we're at 4.75 today, and we've also seen, you know, in September, it's also, the three-year also has gone up 30 bits, so this makes it a much more attractive level to enter into high-yield due to the higher rates, and also, high-yield right now is at a 7.7% yield, which is very attractive.
To date, high-yield is 1.6, it's one of the top performers following loans, which is up over 3%. Currently, with the higher oil prices above 100, and the rising inflation has caused high-yields to go up to a six-month high. The last time we were at 7.7 was when we were entering the Iran conflict six months ago.
Now, high-yield has been very resilient this year, with spreads barely moving since the beginning of the year, and although we've seen geopolitical tensions, Fed policy uncertainty, those spreads have barely budged. And why is this? This is because high-yield has very healthy balance sheets and strong credit metrics that have supported the asset class.
Also, technicals are strong. We have over $220 billion in gross issuance, yet net new supply is only $70 billion if you start discounting all the calls and tenders. This also has been supportive of the asset class.
And we've seen strong demand from investors and flows as well into high-yield. Now, what is our outlook? We are expecting within the next 12 months high single-digit returns coming from carry, not price appreciation.
So, with this compelling 7.7 yield, it's a cushion should rates continue to go up and we see price appreciation. As we've seen this year, although rates have gone up, we have positive returns in high-yield. We don't expect any deterioration in the asset class and we are keeping our attractive view.
Now, default risk remains low at 1.7. We're forecasting a slight increase over the next 12 months to 2%. Duration is low under three years, to be exact, we're at 2.8 years.
So, if you take all of this collectively, higher elevated yield, low duration, low default risk. The asset class is well-positioned to deliver high single-digit returns and the 7% yield is attractive for those investors that are searching for yield and looking to diversify in their portfolios. And the asset class is positioned with higher credit quality than it was in the past.
So, we recommend investing in ETFs or mutual funds to have diversification versus investing in a single individual high-yield bond. Thank you, Lenny. That was a great summary.
Again, we did move our sector allocation to an attractive for high-yield spread. As you mentioned, there's still a bit of bifurcation or dislocation within the high-yield universe, but overall, spreads are attractive, their credit quality is double-D, and that lower interest rate risk and that kind of compounding income we think is really going to be attractive over the next six months to a year, particularly because we think that short-end has actually moved up too much. So, I want to just shift now from the credit side to the higher quality, and Barry, I want to turn to you because another sector that we have actually just recently moved to attractive is investment-grade, and I know that as you cover investment-grade corporates, you are well aware of these tight spreads, but still have the ability and the outlook of fairly positive returns.
So, how do you see the Fed moving, and what do you think over the next six months in terms of performance? Yeah, thanks, Leslie. As you mentioned, we recently moved to an attractive view as a way to embrace the duration of the asset class.
We think IG corporates should benefit more from the duration or at least not be an attractor that we've seen year-to-date because the total return of investment-grade is only slightly better than Treasuries, both down over 1% year-to-date, so we think that the outlook ahead will be driven by the yield, the coupon, and the IG index yield is currently 5.75%. It's about the highest that we've seen in over two years, but really across the curve, you know, you're obtaining yields that are over 5%, especially now even on the short end after the rise in the two-year Treasuries, or even like one- to three-year IG is yielding 5.1%. So, we do find opportunities across the maturity spectrum of IG, and if you're searching for a 6% yield, you can go out to intermediate maturity, seven- to ten-year BBBs on average do yield 6%, so that's quite compelling, and we think that will shape the return outlook, you know, a lot better going forward as yields, not only are they at higher absolute levels, but you know, we think that the bit more clarity that we're getting about Fed policy as it evolves should maybe take some pressure, particularly off the long end.
It's good for investment grade because, well, you know, these companies are among the highest quality large companies, you know, in the U.S. and abroad, so they're really not pressured by higher-rate environment, and we think that the demand environment for IG corporates does benefit on the whole when you have greater stability in the rates market, you know, if investors are a little bit hesitant to go out the curve, you know, that could be a headwind, but if we do see more stability, particularly, you know, in intermediate and longer-dated maturities, that should bode well, you know, for the IG asset class, and yeah, you know, it's really been a story of resilient spreads, the index level, the spread of 78 basis points is nearly unchanged here to date, but when you open the hood, you know, there has been some differentiation among industry sectors, most notably you've seen weakness on the tech side in hyperscaler because of the supply index of hyperscaler debt is about 25 basis points wider this year versus, let's say, the energy sector where higher oil prices have benefited the sector, so you see spreads that are like 14 basis points tighter on the year, so there's been dispersion, despite the fact that spreads really haven't moved here to date. I think that environment is going to persist, so at the index level, I'm not expecting to see spreads materially move in one way or another, probably stay, you know, near these historic tights, but, you know, should allow for an environment, yeah, for investors to capture the carry, and maybe just to wrap up, you know, I'll mention hyperscalers because they have been such, you know, a prominent story in the investment grade asset class, you know, this year. The debt that they've issued, they've done so at such a rapid pace going back to last fall, you know, from very low levels, the high quality hyperscalers like Amazon, Alphabet, Meta, really historically haven't issued a whole lot of debt that's really ramped up, you know, to satisfy their CapEx funding needs.
We do think, however, that they may have pre-funded some of their needs even for next year, so I know you might see stories of really high numbers that relates to just AI investment in general and hyperscaler funding. We do think that kind of the gross issuance amount that we've seen this year, which has been roughly about $200 billion for these higher quality like AA rated hyperscalers, we're kind of expecting a similar amount next year, and we think that should be easily digested, you know, by the market. So, yeah, there is upside to that number, you know, for sure, but, you know, we do think that because of their high ratings, you know, absolute yield environment, you know, and the fact that they should maintain their existing ratings, even as they add debt to the balance sheet, they have, you know, pretty high buffer before you face downgrade risk, so for all those reasons, we think that, you know, hyperscaler issuance, you know, while would remain robust next year, again, should not be really a headwind for broad spread.
So, yeah, that just kind of sums up our view for IG. We do think better return days are ahead, and, yeah, just I think the fundamental and supply demand backdrop should stay generally favorable for the asset class. I can turn it back to you, Leslie.
Yeah, thanks, Barry, and, you know, I think the important point, too, regarding the supply issue, I think the market was, and I know you would agree, you've talked about this, but really underestimated the amount of supply that was potentially going to be seen in 2026. I think they've readjusted to that, and as we all know, our equity team is anticipating about $900 billion in CapEx in 2026 and about 30% higher, but maybe about $1.2 trillion in 2027, but we do think on the corporate side and the debt financing, which will continue, but the market has sort of adjusted, now adjusted that higher supply, in our opinion, and we do think, as Barry had mentioned, it's a good time to move to attractive and investment-grade corporates, so thank you, Barry, and I just want to shift now to Sadiq and the municipal side. Sadiq, I know that, you know, in the beginning, we were talking about just the rate of change in treasury yields across the curve since the day before Jackson Hole until yesterday, and we know, as I had mentioned, you know, you're talking about a pretty big spike in interest rates, which can be a headwind to the municipal side on top of supply, so what is your outlook for, how do you see this for relative value now, and what's your outlook for the next three to six months?
Yeah, happy to comment, and thanks for having me, Leslie. Yeah, that's exactly right, the spike in yields took a toll on MUNI's, so just to recap performance, that spike surging treasury yields happened to coincide with weaker technicals in the back of record supply and tax-related selling, and MUNI's quickly went from leading at mid-year to being one of the worst performers in the fixed income, U.S. fixed income landscape, with a year-to-date total return of minus 1.7%, even though after closing up for coupon income of the highest federal tax bracket, actually the adjusted return is still positive, but that said, the index is really underperforming, and it's really a, before I come to the outlook, it's a four-legged stool. Yields attractive, relative value much improved, technicals a near-term headwind, and credit is resilient.
That's really the framework that I'm looking at. Just to go through the individual items quickly, yields is the most important story. You've mentioned this, Leslie, several times, starting yields is the biggest and most powerful predictor of long-term total returns, and those yields are really attractive.
The AAA 30-year MUNI yield reached a high since 2011. The index yield at 4.3%, that's a tax-equivalent yield of 7.3%, is very attractive. Look at in-state bonds of California and New York, that's approaching 9%.
Long-dated AA5s trading below par, those are all strong buy signals. The curve is very steep. The AAA curve is much steeper than its own history, and it's far steeper than the Treasury curve, implying duration is cheap.
That said, technicals continue to remain weak, and will get weaker, in our view, in October. There's a lot of supply in the market, and demand this time of the year is tepid. That will change towards the end of the year, but we're still in a very weak technical landscape.
Credit remains sound, resilient, supported by a strong economy. All the core infrastructure sectors have very strong credit fundamentals. Spreads are relatively tight.
There's no real reason to go down the credit spectrum when long-dated high-quality is trading so cheap. Outlook, fourth quarter outlook, is much better from here. I think it should do well in fourth quarter.
With a 12-month period, it should do very well. I think the key here is the level of yields. The tax-equivalent yield is really attractive.
We have investors in those highest tax brackets who have a long-term horizon. These are excellent entry points into the mini-market. We hope to see fourth quarter performance being much better.
That is, if rates cooperate. But now that the Fed has raised rates, it seems like fictions of markets are calmer. The rate markets are calmer.
Munis are actually trading firmer across the curve, post the Fed meeting. So I think these are some good signs, and these are some really good opportunities to put money to work in the mini-market. Thank you for tuning in.
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