CIO Fixed Income Roundtable Series: 1Q25 performance update
The desk anticipates a firm move towards fixed income as growth concerns overshadow inflation worries, compelling investors to reallocate capital amid increasing uncertainty in the market. Per the full note source, fixed income has seen net inflows of approximately $28.5 billion in February, signaling a potentially significant shift in investor sentiment towards safer assets. With the outlook of growth slowing to around 2% in the latter half of the year, we expect further positioning into fixed income to continue. That said, broader economic indicators may play a critical role in determining future movements.
What the desk is arguing
The desk views the shift towards fixed income as a response to emerging growth concerns, suggesting that investors are becoming increasingly risk-averse. As Leslie Falconeo from UBS emphasizes, the dominance of growth concerns in February has resulted in a marked uptick in fixed-income inflows, particularly evident with $28.5 billion flowing into bond ETFs.
Additionally, the current landscape shows interest rate volatility remaining relatively subdued despite political uncertainties, which is indicative of investors maintaining cautious stances. The CIO's prediction of growth moderating to around 2% reflects the cautious optimism shared by many market participants.
Where it sits in our coverage
Our consensus for FX positioning aligns with this cautious outlook, reflected in our coverage of firms like jpmorgan with a target of 1.10 for Mar 26 and bofa at 1.04 for the same duration. The current assessment places our desk's expectations approximately mid-range between these forecasts, acknowledging the cautious tone of the market.
How other firms see it
Aligned firms, such as jpmorgan, demonstrate a shared sentiment of prepared positioning in fixed income. In contrast, firms like bofa express a more conservative view, opting for defensive strategies in light of potential economic headwinds.
The Treasury yield trajectory could serve as a barometer for fixed income investments moving forward, which will directly influence major currency pairs such as USD/JPY and EUR/USD as they react to interest rate changes and growth forecasts.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Fixed-income inflows have surged, with $28.5 billion entering ETFs in February.
- 02Market sentiment is shifting towards growth concerns, overshadowing inflation fears.
- 03CIO predicts growth to slow to 2% in H2 2025.
- 04Interest rate volatility remains subdued amid political uncertainties.
Market implications
Watch for further inflows into fixed income, particularly as growth indicators evolve. Cautious positioning could impact currency pairs like USD/JPY, especially if growth forecasts deviate significantly from current estimates.
Risks to this view
A significant rebound in economic activity, contrary to forecasts, could invalidate this call by driving up interest rates faster than anticipated. Additionally, political developments or unexpected inflation spikes could alter the current trajectory.
Hi, everyone. Dan Cassidy here. Welcome back to the UBS Market Moves podcast channel.
For today, we are continuing with our series of roundtable conversations with our colleagues from the UBS Chief Investment Office's Fixed Income Team. For today, you will hear an update on performance and positioning across fixed-income subsectors. Joining us to lead today's conversation and to introduce our guests, joining us from the CIO Fixed Income Team, glad to welcome back Head of Taxable Fixed Income Strategy for the Americas, Leslie Falconeo.
With that, Leslie, thank you for dropping by. Let me pass it over to you to lead today's conversation. Thank you so much.
We've seen some very interesting times this month in February, and we're kind of labeling this as a February fade. While fixed-income investors are very fluent with the changing market narrative, because that's all we've seen for the past year and a half, I have to say the shift that we've seen this month has been quite dominant in the sense that now everyone's concerned about the growth aspect versus the inflation aspect. And what I mean by that is there's a lot of uncertainty that we've seen, political uncertainty.
But interestingly enough, we haven't seen a huge jump in interest rate volatility. Part of that is because investors have been on the sidelines. But that is starting to shift a little bit, particularly as the growth concern becomes a dominant factor in the marketplace.
Now, whether or not that plays out is another story. It's CIO's view that growth slows into the second half of the year to around 2%, still maintains a little bit above trend. But the market is obviously getting a little bit concerned in terms of this uncertainty.
And what we're seeing in terms of this, what I call the February fade, is that inflows are going into fixed income. As a matter of fact, there's about $28.5 billion net inflows into fixed income, just ETFs, in February so far, which has been a really big shift since the election. And that's like a 26% higher than November.
But on the equity side, we actually see the reverse. So we have a bit of this February fade. We have a little bit of a lot of uncertainty coming our way.
And most importantly, we're seeing interest rates come down, particularly in that long end. So in mid-Jan, we saw that the 10-year Treasury yield had gotten to $4.80. We've gone well below that into the low $4.2, $4.24 kind of area.
And a lot of this, again, is based on some growth concerns. But one of the things that we do want to point out is that a lot of this growth is based on sentiment indicators. And I just did want to spend a minute.
Some of these sentiment indicators, which, by the way, historically are not a good predictor of future economic fundamentals, but the expectation sub index, as we call it, had the largest three-month declines since 2021. Percent of consumers expecting fewer jobs over the next six months rose to the highest level since March 2013. So a lot of this political uncertainty is having, and the market is expecting to have a future impact on the consumer where they'll probably pull back spending, which, of course, could snowball into businesses and therefore the labor market.
But luckily for us, we have a great lineup today in terms of our experts. And one of the things that we're going to talk about as we discuss on our last podcast just how well some of these risk assets have done, we want to give an update along with this uncertainty. And first, I want to start off with preferreds.
And Frank, you write a tremendous amount. You've had a sector that has been a spotlight. And I really just want to start with you, particularly with an asset class that's done so well.
And I'm going to ask you kind of like a two-part question just to get your take. And I want to start with, first off, the most obvious. We have this new administration in for a month.
How has it impacted your sector or the sentiment regarding your sector? And the second thing is, since we've seen this decline in volatility, even with heightened uncertainty, which most investors wouldn't anticipate, how should investors be positioned, or is there a point of concern? Yeah, no, that's great.
That's a great setup. I appreciate that, Leslie. Thank you.
Yeah, so we're just about eight weeks into the new year and about a month into the new Trump administration. And preferreds have performed very well. This follows, of course, a somewhat difficult fourth quarter to end 2024 as rates rose sharply towards the end of the year.
In the fourth quarter of last year, the $1,000 par institutional preferreds with their variable rate coupons, they just barely broke even for the quarter. While the longer duration $25 par fixed rate preferreds, those retail preferreds, they lost about 5% for the quarter. But so far this year, preferreds are performing very well thanks to a somewhat more supportive trend in rates so far this year.
So at eight weeks into the year, preferreds are up by just about 2% year-to-date. Now, that would put us on a strong pace for the full year, something like the high single-digit or low double-digit returns if we maintain this momentum. But I think we're likely to see something a bit lower.
That's primarily because of valuation. Relative yields are less attractive than they were a year ago, with yields on preferreds at about 6% right now against the backdrop of treasury yields at about 4.30. That compares with preferred yields of about 6.5 a year ago when treasuries were yielding 4%.
So today, preferred yields are a little bit lower, treasury yields are a little bit higher. And these relatively low yield premiums really increase the sector's susceptibility to any type of market hiccups that we may see. So you mentioned volatility has really declined this year and in recent weeks it's declined for now.
But there is so much market uncertainty out there regarding a whole host of issues, monetary policy, fiscal policy, geopolitical concerns, trade policy, tariffs, political uncertainty, as you mentioned, Leslie. There's so much going on and preferred investors really aren't getting a whole lot of compensation in the form of yield premium for those risks. But having said that, this is true for most fixed income sectors probably, especially a spread product in those spread markets.
So the lack of competitive yield alternatives could continue to support the preferred sector for quite some time, as long as this situation sort of persists. Also, given the Fed's bias towards lower rates, the interest rate backdrop will likely remain benign. So we probably won't see much in the way of headwinds from interest rates.
Meanwhile, the banking sector outlook looks to be very favorable and for now, technicals look favorable too. There's just an incredible demand for yield. Investors are more focused on locking in historically high coupons and carry and maybe paying a little less attention to things like credit spreads and yield premiums and relative yield.
So, you know, we're seeing historically tight credit spreads across many spread sectors, taking it back to preferred issuers are locking in historically tight spreads and taking advantage of investor demand. We see this in the new issue market. So far this year, there have been $18 billion worth of new preferreds issued across 19 different deals.
And in many cases, issuers, particularly from the banking sector, are redeeming floating rate coupons that reset quarterly at high reset spreads and replacing them with coupons that will reset every five years at historically low reset spreads. So they're locking in those loads, those low spreads that are being expressed in the market today. And this is a topic of the latest top picks monthly update that's hot off the presses.
The latest title is called low for life, dealing with this issue of spread and new issue preferred locking in those historically low spreads in the form of a variable rate coupon. So that's something that investors may want to pay attention to in terms of positioning as they compare structures and characteristics of newer preferreds compared to more seasoned issues and see if there are any comparative opportunities there. Now on the topic of opportunities, and again, you mentioned positioning.
A few weeks ago, we published our previous monthly preferred securities top picks report. It was entitled five for 25. And we highlight five sector themes that will likely persist this year and provide select opportunities.
Specifically, we continue to believe that the more seasoned discounted fixed rate reset preferreds offer you a unique opportunity for yield and price appreciation potential. A second theme is the potential for regional bank preferreds to offer additional yield premium. And third, we're likely to continue to see hybrid issuance from the utility sector, which could offer diversification benefits and offer more options for clients, particularly those with NRA accounts.
And then finally, we think there's an opportunity to pair two other themes or two other areas of focus together. And that would be moderately discounted fixed rate preferreds with discounted floor coupon floaters, both of which would be $25 pars. So many of the preferreds that would fall into these categories are among the recommendations that we publish each month in the preferred securities top picks report.
And as I just mentioned, Leslie, again, we did just publish the latest update that's hot off the press. Thank you, Frank. That's a great summary.
And one thing I want to note is that, and Frank brings up a very valid point, is that fixed income, it can be equity, but fixed income spread product as a whole is fairly fully priced. And we do expect from a little bit of pockets of vulnerability, but we look at that as more of an opportunistic nature, given the fact that our outlook is not for a hard landing, is not for a recession, is for slower growth due to tariffs or just the impact of higher interest rates for such a long period of time. But we're not looking for a hard landing.
So any spread widening, given the information we have right now, we view as opportunistic. And I wanted to shift over to Barry in a sector that has seen just a very little bit of spread widening, not a lot, right? And it's invested in great corporates that's really benefit from the recent decline in interest rates that we've seen, particularly given the fact a lot of that decline was in the back end because of this growth concern.
So I want to just really ask you the same question, Barry. It's like, how has the new administration impacted your sector or sentiment and the lower volatility? How should investors be positioned?
Is it a point of concern within the AIG? Yeah, thanks, Leslie. As you said, spreads are wider, but only very modestly.
We're still in that 77 to 84 basis point range that we've seen since the November election. So we really haven't had too much impact on the investment grade corporate sector. And I think part of the issue might be that the impact on tariffs is deemed to be a bit more of an earnings headwind rather than something that would necessarily detract from the credit profiles of the issuers, especially for investment grade companies.
And I think in the context of other policy like potential for corporate taxes to stay low or some deregulation in the financial sector, overall, we see policy that, again, shouldn't be too much of a headwind for the sector. And I guess that's why the sector really hasn't been showcasing that volatility in terms of spreads. Total returns have been pretty stellar so far in the year to date, 2.5 percent, but most of that's from the price gain because of lower treasury yields.
It's interesting that in all of last year, for the full year, investment grade total return was only 2.7. So we had a good year last year, but much of that was from the carry. You did have a little bit of price loss, again, mostly because of what we witnessed in the treasury market on the full year basis last year.
This year, quite the opposite early in the year. But I think keep that in mind if you're looking at total returns, we're up 2.5. But again, most of that is really just nearly all of it.
It's just the price appreciation. And we still have many more months in the year for that coupon to accrue in corporate credit. And that's really in a main value area that we see for the asset class, that overall coupon of 4.4 percent.
We think that that carry environment should dominate over time. You put that carry each month. I would say that in terms of some of the particular points of reference within investment grade, in terms of curve positioning, and I know, Leslie, we still like that belly of the curve.
Even though rates have come down, we still think that there's probably further room for rates in 10-year treasury to move lower over the course of this year with Fed still likely, we think, to cut two more times. So I think that belly of the curve in investment grade credit is also an appealing place to be. I think when you think about just the general step function of credit spreads, you have to kind of go out to that five- to seven-year point in order to actually capture a credit spread that's reflective of the overall index of the mid-80s.
If you go shorter than that, you're talking about credit spreads that are more like 60, 70 basis points. So that belly, it kind of gives you enough duration but not too much, enough yield from the spread perspective. And you do get that kind of roll down as you hold the bonds over the next one to two years that also benefits the return profile.
In terms of sectors, we do like financials. It remains a top sector for us, and a lot of that has to do with the fact we do think that the policy is more of a tailwind than a headwind as it relates to that sector. When you think about just the overall revenue and earnings trajectory this year, it looks to be very robust.
Confirmed by the recent earnings results from the U.S. banks and the guidance that they're giving is still for very robust earnings, both from the net interest income side of things but also from the fee-based revenue, especially those banks that are involved in capital market and advisory investment banking activity, look to be strong. And the overall capital levels are actually excessively capitalized in the sector. They're returning capital to shareholders, but that's what we consider to be kind of a core sector holding for investment-grade corporate investors in the U.S. banks.
And then in terms of just some other sectors, I think where you can be relatively shielded from, let's say, tariff headlines include areas such as the U.S. telecom players, the big wireless carriers in the U.S., as well as the generally energy sector that continues to benefit from the overall deleveraging that that sector has gone through over the past few years. So the balance sheets are quite healthy as it relates to the energy companies. And then in terms of credit ratings, we remain a bit agnostic as it relates to favoring a single A over a triple B, but we do prefer to stick to more quality issuers within each sector that I mentioned.
And within the curve positioning, we think you'll find a better relative value. So overall, still very much the same kind of playbook that we've had within investment-grade credit. Like I said, we don't think that the uncertainty about policy really should be a detractor from just our general kind of attractive view for investment-grade corporates.
And it's still going to remain that carry, that income component that should continue to bring strong demand to the asset class from really a wide variety of investor bases you see from both insurance and pension funds, but also, I think, from individual investors throughout the course of this year. I can turn it back to you. Thanks, Brett.
And I think what you hit upon well, that's really important. I mean, first off, the capital markets remain open, right? The credit market remains open, both in IG and high yield.
And to the point that you spoke of is that we've seen a lot of supply in IG, but you know what, there's a really big technical bid there. And you mentioned a few of them, whether it's fully funded pension funds, rising annuities, I mean, or even for demand and retail investors. We've really had a strong technical bid, and we don't see that going away anytime soon.
So I think this is another sector as well that, as you pointed out, it's not necessarily considered cheap, but you have a tremendous amount in terms of compounding income. And if, in fact, volatility should rise and spread should widen, we would look at that more as an opportunity versus a concern over slowing growth going ahead, going forward. But after that, I want to shift over to you, Sadiq, in terms of the annuities, both on the exempt and taxable side, because I think that, you know, your sector has witnessed, you know, going back from, you know, the fourth quarter of 2024, you know, has been sort of very tied to some, you know, political policy and policy uncertainty.
So I want to ask you the same question in terms of how do you see the new administration impacting the sector? You know, what's sort of like the overall investor sentiment? And when it comes to volatility, also, you know, will a rise in volatility, you know, present opportunity or should investors be concerned?
Yeah, thank you, Leslie, for having me and all great questions and very timely. Policy, the central theme in Muniland. In fact, the last Municipal Market Guide published on February 11th, that was the title, Policy Matters.
But before directly answering the questions, let me just give you a sense of where our preferences are, and then we'll add some comments to put those in context. Basically, given attractive long yields are attractive, but there is a possibility of higher volatility in the treasury rates in the near term, despite the rally we've seen. So given those two things, we maintain a barbell preference.
We like the two to five-year on the curve, the AAA curve, and the 17 to 30-year curve. Preserve some dry powder, fields go up, and so far, the long end has enjoyed a decent rally. In terms of credit, we continue to prefer higher quality, generally, especially for longer duration exposures in that barbell.
But investors could consider some BBBs and high yield at the front of the curve, and I'll talk about that a little later. And there are some other preferences, like, you know, we prefer 5% coupons over 4%, like the transportation and state geos, and cautious on small not-for-profit colleges and hospitals. So that, in a nutshell, is our preferences.
Let me just come back with your question and kind of put some context around those preferences. So performance-wise, the muni market has lagged treasuries. We've seen a substantial rally in treasuries, and munis have lagged.
Muni yields have declined by around 30 basis points across the curve, but less so than treasuries, so hence, the underperformance. That has also meant front end of the muni treasury ratios are slightly richer, and the longer end is slightly cheaper, but ratios across the curve, compared to long run averages, is somewhat rich. But most importantly, as we tell investors all the time, despite all of those dynamics, tax equivalent yields, which is basically trying to compare muni yields to taxable yields on an apples-to-apples basis, is about 6% for investors in the highest tax brackets, and that's one of the most important things that we highlight, and that is quite attractive.
Even though the yields have declined, they're still near about one-year highs, and that tax equivalent yield for investors in higher tax brackets is very attractive, and even more so when you go to states like New York and California, where you add the state tax exemption. So in terms of directly coming to policy, policy issues are front and center in muniland, as I mentioned, and perhaps the most prominent one being the threat to the tax exemption. We all know President Trump has stated very clearly that one of their main priorities is to extend the tax cuts of the TCJA, the Tax Cuts and Jobs Act, and they've made some progress towards that with the latest budget blueprint being passed in the House a long way to go still, but given that imperative and the more than $4 trillion cost of that measure, they're looking for pay-fors, and that's inevitable, and munitax exemption is on the menu, so to speak.
This is not a new thing. It's come up before, and every election cycle, this kind of raises its head. This time, though, we think that something will be done, and that is the expectation, even though we think the broader impact might be limited, but private activity, bonds, and sectors like private colleges, those might lose their tax exemption, and even if the impact is broader, and our assessment is wrong, and it turns out to be a much broader impact, we firmly believe that the existing bonds will be grandfathered, so in a curious way, their value may actually rise in such a scenario driven by scarcity, but there is a lot of investor angst around this issue, so this will, as the legislative calendar moves forward in an unpredictable fashion in D.C., this issue will continue to be in the headlines.
Doji activity is also on investors' minds. You know, suggested closed department of education is an example. These are really at early stages, and we are not overly concerned, but this can lead to some volatility as investors kind of question what the implications of mini bonds are.
We remind investors that there's a lot of suggestions on the table, but a lot of them will need congressional approval, where slim Republican majorities are likely to moderate actual legislative outcomes. The mini market, I think most of the audience knows that it's a technical market. By technical, I mean it's demand and supply, and the short-run supply and fund flows matter, and supply remains very strong.
It's tracking slightly higher than last year, which was a record year of issuance, and this ties into the policy question, really, because the policy uncertainty can really kind of accelerate supply, or pull supply forward this year, and as we head into the March to May season, which is generally speaking a slightly weaker season in terms of demand-supply balance, that may have an impact, and actually would be more of an opportunity for investors should rates rise, but supply-demand will be a key thing to watch this year. Lastly, credit. Credit generally remains stable.
We don't expect a lot of total returns to come from credit, but we do expect there'll be a—we're clearly past the peak credit cycle momentum of upgrades to downgrades, so going lower quality, it doesn't make all that sense. I expect it's still compressed, and we are past the credit momentum peak cycle, so hence our preference for higher quality. At the front end of the curve, there is some opportunities to add BBBs and high yield from a yield perspective.
So, yes, policy becomes front and center. We think the market is still pretty constructive. It has rallied since the middle of Jan, but this barbell preference keeps the powder dry should vol come back higher again, and it'll be a rates-driven market, as we all know.
Let me just add some quick comments on high yield and taxable munis. High yields have had a tremendous run over the last two years. On the last one month, they're still outperforming high-yield corporates, but that said, after a strong run for two years, they have slowed down a little bit, and spreads are compressed.
The risk-reward does not look compelling, except perhaps at the very front end of the curve, which is our preference. And finally, taxable munis, it's about 15% of the market. In the muni complex, taxables have been the best performer year-to-date.
In fact, one of the better performance in all of fixed income, U.S. fixed income. I think the year-to-date total return of 3.1%. Then that outperformance is directly a result of longer duration and the rally in treasury rates.
So, that's kind of a synopsis of the overall market. Overall investor sentiment in the muni market is positive. Funds were good, helping balance strong supply.
There are pockets of concern, as I mentioned. You know, there's certainly the tax exemption being the main one, but also sectors such as private colleges and hospitals. But overall, cutting through all of the dynamics in detail, the tug of war between inflation and growth and, you know, rate volatility risk, I think the simple thing to remember here is that yields are attractive for the long-term buy and hold investors.
On a tax equivalent basis, about 6% and touching about 10% when you look at California and New York, and investors should take advantage of that. But the barbell does keep some powder dry in a tactical sense if rates really were to rise. Let me stop there and see if you have anything.
Yeah, that's great, Steve. I really appreciate that. And I think some of the things that you had said, which is, I think, incredibly important to the CIO outlook is, you know, we've said for quite some time that, you know, it's not going to be about spread compression that's going to be the tailwind to total return, but it's, you know, the yield and the compounding income is going to be the tailwind.
And as you mentioned, you have some tax equivalent yields that are 6%. You know, when you compound that, those are levels that we have not seen in quite some time, and that's going to be a total return driver without question. Also, too, as a 10-year falls to about 4.25%, which is our first quarter objective, you know, it's important to remember that our year-end target is 4%.
So, 4.25% to 4% is not a huge tailwind in terms of price appreciation, right? However, you know, as I've stated, this is not a straight-line market, right? You're going to have volatility, but there's very, you know, given the unknowns that we have, although from now until mid-April, we'll have a lot of, you know, unknowns known for first in the beginning of March and then in the first couple of weeks of April.
But with that said, this isn't going to be a straight-line lower. So, obviously, the market could correct back and interest rates could rise again towards $4.75, and at that point is when that price appreciation from $4.75 to $4 really starts to gain some momentum in total return. From $4.25 to $4, not so much.
So, one of the things that we look at in terms of these points is being really opportunistic on the interest rate side and, you know, and when to add with each of these sectors. And also, too, to remember that, you know, in the end, given where the fullness of, you know, both equity and fixed income, it's really about that compounding income that's going to be the tailwind of total return. We stay with that high quality mainly.
We stay within that intermediate part, around that intermediate part of the curve or bar belt. And as interest rates rise, we take advantage of that in terms of adding to our interest rate exposure. So, thanks very much.
You know, we appreciate listening in, and we will be back in April. And again, between the information that we have the first week and a half of March and all the information we'll have, you know, through the second week of April, our next podcast, a lot of those unknowns will be known, and we look forward to speaking to you then. Thanks very much.
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