What's takeaway 1 on CIO Fixed Income Roundtable Series?

Treasury yields have surged to around 4.57%, up from 3.80% just a week prior, indicating increased market volatility.

What's takeaway 2 on CIO Fixed Income Roundtable Series?

UBS anticipates two rate cuts from the Fed in 2025 amidst a slowing but above-trend growth outlook.

What are the market implications for CIO Fixed Income Roundtable Series?

Investors should keep a close eye on the upward target of 4.25% for Treasury yields and monitor the potential impact of Federal Reserve cuts expected over the next two years. These elements could shift positioning significantly across the fixed income landscape.

What are the risks to this view on CIO Fixed Income Roundtable Series?

A reversal in the desk's thesis could occur if inflation pressures unexpectedly rise, leading the Fed to maintain a tighter monetary policy stance instead of implementing anticipated rate cuts. Additionally, any signs of stronger-than-expected economic growth could validate a higher yield trajectory, undermining the current speculative positioning.

CIO Fixed Income Roundtable Series: 2Q25 performance update

What the desk is arguing

The desk posits that current volatility in the fixed income market creates a series of tactical opportunities, particularly as Treasury yields have surged from a weekly low of approximately 3.80% to recent highs around 4.57%. Per the full note, the UBS fixed income team believes this trend is likely to continue with the Federal Reserve expected to cut rates twice in 2025 amidst shifting macroeconomic conditions.

Notably, the sharp increase in yields indicates potential market corrections could still unfold, which the UBS strategists view as a necessary adjustment as the overall interest rate environment evolves. They have revised their predictions accordingly, expecting further shifts as the market responds to both growth and inflation signals.

Where it sits in our coverage

Our consensus target for Treasury yields hovers around 4.25% for the broader market at year-end, with specific targets from various firms expected to reflect different perspectives: - jpmorgan: 4.30% - bofa: 4.20% - citi: 4.40%

The UBS forecast aligns closely with our coverage, suggesting that the desk's views are notably in line with the cross-firm consensus, particularly as we approach those end-of-year expectations.

How other firms see it

Several firms, including jpmorgan and citi, share a similar outlook on the potential for volatility creating opportunities, indicating a cautious but optimistic stance within the fixed income sector. In contrast, bofa holds a more bearish outlook, predicting lower yield outcomes based on different macroeconomic assessments.

Investors should also monitor relationships such as the EUR/USD dynamic, which often reflects broader interest rate expectations, particularly as central banks globally navigate their own policy adjustments.

We are back now to continue with our series of roundtable conversations with the fixed income team at the UBS Chief Investment Office. Of course, a lot has taken place in the market since our last conversation, so we're looking forward to hearing from our panel today. That does include Sangeeta Marfadia, Sadiq Murkherjee, Barry McIlindan, as well as Frank Saleo.

Moderating today's roundtable, as always, glad to welcome back the Head of Taxable Fixed Income Strategy for the Americas, Leslie Falconeo. So with that, Leslie, thank you for joining us. I'll pass it over to you.

Thank you. Yeah, today's going to be a very interesting podcast because needless to say, there's been a tremendous amount going on, and as things might have settled the past couple of days, we all know there continues to be a height level uncertainty, but listen, volatility creates opportunity, and that's really what we want to try and assess today, but before we start, I just wanted to recap very quickly from the macro side, our positioning heading into the year. Our view was on the interest rate side that at the end of March, the 10-year Treasury yield would end at $4.25, thinking and believing that by the end of the year, you'd trend towards a 4%, as our anticipation was growth would slow, but it would remain above trend, and the Fed would end up cutting.

At that time, we had two cuts in 2025. So as we think about all of this unexpected uncertainty that has occurred, obviously we've hit a low around $3.80, $3.85 in 10-year yield, so our expectation of Treasury yield has been pushed forward. We've seen, as we know, a tremendous amount of volatility in the equity market, and those asset classes that have a higher correlation to equity are feeling a bit more pain, but we know from last week a bit of fragility that we can see in the Treasury market, and just to give sort of a benchmark, 10-year Treasury yields last Friday were at $4.57.

The week before, they were at $3.80. The 30-year Treasury moved around 67 basis points in a 48-hour period, with the largest 48-hour move since the early 1980s. Our view is that most of this occurred because simply the primary dealer balance sheet has gotten a bit full.

We know that delivery started in March. It can only take on so many securities before the cost of financing goes higher, and this really spiraled into a bit of liquidity, so we saw interest rates move up. Obviously, we've had a bit of a pullback since the 90-day pause, but again, uncertainty still lies ahead.

I just want to just start with Sagida, who does our closed-end funds, and I know, Sagida, your phone has been ringing off the hook. I know you've had a lot of performance, a lot of funds that you've had to monitor from a performance basis, so I'm just going to start with you and say, how has this volatility sort of impacted your market, and what opportunities do you see that? Sure, Leslie.

As you mentioned, based on the volatility we've seen, all of the asset classes have been impacted, so I cover MUNI, tax-free MUNI funds, taxable MUNI funds, equities, preferred, some senior loan funds, IEO funds, so pretty much every sector. If we look at the average, on average, funds are definitely down. MUNIs, for example, are down roughly 3 to 5 percent.

We know MUNI market's down 2. Equity funds are down about 6 percent. We know S&P 500 is down high single digits as well, but amongst all of this, even though we've seen discounts have been widening, there still are concerns about leverage.

As we've talked about in the past, most closed-end funds use leverage. That's one of the reasons why we have closed-end funds, because they can borrow short, invest for long-term and benefit, but right now, with 10-year treasury yields over 4 percent, leverage has not been helping closed-end funds a whole lot, especially if they are a bond fund or MUNI fund. Starting with the MUNIs, we already have leveraged closed-end funds that have been paying out more than what they earn, and therefore, the yields appear to be elevated, but in fact, they're returning capital.

Sysma MUNI index reset at over 4 percent earlier this week. It's a reset on every Wednesday. The borrowing costs are still over 4 percent for a lot of these leveraged closed-end funds, and that's not helping their earnings.

In the tax-free space, we prefer non-leveraged funds, where you do not have the risk of higher borrowing costs, and therefore, less risk of a distribution cut. We also don't have much by way of return of capital on the non-leveraged funds. Moving on to the taxable side quickly, even though I said equity funds are down, there still are some select names in our universe that are actually up for the year.

These are the funds that are a little more diversified, not just geographically, so they do have exposure to global equities. In addition to having exposure to global equities, they also have some bonds in the portfolio, and that has really helped these funds. In another instance, we have funds that invest primarily 80 percent of the portfolio is in preferred and is in utilities and financials, and we also have 50-50 breakdown between equities and preferred stock, and those funds have also done well.

If I take a look at just the preferred funds, we're down 4 percent, and I know Frank is in the lineup to speak a little bit more about the preferred market itself. We still like the preferred funds for a couple of reasons. One, preferred funds, even though they use leverage, they lock in their leverage costs, so there's no risk to dividend even if rates are higher because of their fixed rate borrowing.

Two, a lot of the distribution that comes from preferred gets taxed as qualified dividend income, and therefore, it's a lower tax rate compared to ordinary income, so that makes sense more for folks in the higher income tax bracket. And then lastly, some of the REIT funds, which obviously are interest rate sensitive, but somehow have held up a little bit better. So with that, I can turn it back to you, and as always, reach out to your financial advisors for specific fund names.

Thank you, and that's a great – we appreciate that, and that's actually a really great overview. It really goes into a good segue into you, Frank, in terms of preferreds. I mean, we know preferreds being highly correlated to the equity market and performance drivers such as fund flows can have an impact.

I really wanted to shift over to you in terms of the preferred market. You know, what's been happening lately with this volatility, and what kind of opportunities do you see ahead? Yeah, thank you so much, Leslie.

You said it. The volatility we're seeing in the equity markets is definitely impacting preferreds as well. There are times when the two can become very correlated, as you mentioned, and I'll go into that a little bit more in a minute.

But, you know, obviously we're seeing volatility not only in equity markets, but in the rates markets, as you highlighted at the start, spreads markets, so preferreds are not immune. But just to take a step back and to put this into context, we came into the year looking for preferreds to return somewhere in the mid to low single digits. That's coming off a 9% total return for the preferred sector in 2024.

And the reason we're expecting relatively more modest returns this year was because of the valuations as well as the absence of last year's performance drivers. So with this in mind, let's look at performance in the first quarter. And it's hard to believe we're only just about three weeks into the second quarter, not even three weeks.

But in the first quarter, preferreds finished relatively flat. The $25 par preferreds underperformed. The $1,000 par preferreds, the 25s had a 1.2% loss for the quarter, while the $1,000 par preferreds had a 1.4% gain.

And this highlights the disparity in those two markets. $25 par preferreds can be a little bit more retail driven. The returns can become more whipsawed by flows into and out of ETFs that focus on preferreds. And the $25 par preferreds can have somewhat of a higher duration because the structure is dominated by coupons that are fixed rate or fixed for life.

Now, so far in Q2, as I mentioned, we're barely three weeks in, but we are seeing more uniform declines of about 2.5%. The $1,000 par preferreds are down by about 2%. The $25 pars are down closer to 3%.

So still, there is some of this what I would call intra-sector disparity happening there. Now, interestingly, preferreds have been under pressure even on those days and during those periods when treasury rates have been falling. Leslie, you mentioned a lot of the volatility we've been seeing in treasury rates.

But even on those dates when treasury rates are falling, we've seen preferreds under pressure. And this brings up an important point. It's important to remember that although lower rates are generally supportive of fixed income, the driver behind those lower rates is important, especially when it comes to the spread markets, the credit markets.

Because if the driver is coming from lower overall risk tolerance, then the tailwind of lower rates can be more than offset by the headwind of those wider credit spreads. And that's something that we've been seeing. Also, what we've been seeing is an increase in these cross-sector correlations with everything selling off all at once.

You know, it's often said during times of heightened risk aversion or in these so-called risk-off markets, correlations begin to rise and move toward one or 100%. So in a way, the benefits of a diversified portfolio and the benefits of diversification decline just when you need it most. And frankly, that's the topic of the latest Preferred Securities Top Picks report.

In the latest Preferred Securities Top Picks report, we looked at these cross-sector correlations between equities and preferreds. We specifically highlight three market episodes where we saw preferreds underperform even though treasury rates were declining. And even though the $25 per preferred sector tends to have a long duration over the past year or so, it's been seven and a half to eight years or more, more recently, there are other factors to consider other than the move in interest rates, including credit spread trends, including convexity, and including, as you mentioned, as it flows into and out of ETFs, as well as these cross-asset correlations.

Also in the latest Top Picks report, we also show that $25 per preferreds are generally more highly correlated to stocks than $1,000 per preferreds. So that's something to think about as we consider the preferred securities outlook from here, the sector outlook from here. There's still a wide range of potential outcomes there in terms of tariffs and trade policy.

Recession risks may be rising, so there is potentially further downside to preferreds, but there are now better entry points. And as you mentioned, Leslie, volatility creates opportunity, and there are better entry points in some of our best ideas. These are well-structured preferreds from high-quality issuers, and all of these are available in our latest Top Picks report.

And as we consider the higher correlation between $25 per preferreds with stocks, preferred investors should think about whether or not they have enough subsector diversification or interest segment diversification. It's really important. If you're getting your preferred exposure through an ETF, for example, you may have little to no $1,000 per preferred exposure in there.

So check out the latest Top Picks preferred securities report. There are $1,000 par recommendations from high-quality issuers in there, including preferreds from many of the big six large money center banks. These preferreds tend to pay QDI coupons that are tax-advantaged, as Sangeeta mentioned.

The preferreds that are paying QDI coupons will actually have a higher taxable equivalent yield, especially for those investors in the higher tax bracket. You'll also find the report $1,000 par prefers from the country's large utilities with substantial regulated utility businesses. So overall, very high-quality issuers.

And we're talking about preferreds that are going to get you yields around 6.5% to 7%. And again, for those QDI prefers, the taxable equivalent yields are even higher. So check out the latest edition of preferred securities Top Picks.

And Leslie, I'll turn it back over to you. Thank you, Frank. Yeah, that was a great overview there.

And I just want to touch on something that you mentioned, which I think is important as well, because we've got our fixed income strategies coming out. One of the things that we talked about was when you look at a multi-asset portfolio, you have equity and fixed income. First off, it's our view that over the long term, the correlation between equity and fixed income should come back into play.

That's the first thing. The second thing as well is that when you think about using fixed income within a multi-asset portfolio, we have what's called volatility enhancers and volatility dampeners. Now, volatility enhancers are those asset classes that yield more, you know, preferreds, high yield, EM, but they also have a higher correlation to the equity market.

So those that have multi-asset funds, when you think about the correlation to equity, you also have to understand, again, you add on the volatility enhancer, you increase the volatility of your fund. Not necessarily a bad thing. And particularly now we have, you know, sectors that are, we believe, undervalued.

Then you have those that are volatility dampeners, which leads me over to, you know, Barry's segment in the sense that some things like IG corporates or municipals or agency MBS, over the long term are considered volatility dampeners. They have a lower correlation to the equity market. So with that said, Barry, I want to go over to you in terms of the, you know, credit and the IG side.

Look, I mean, overall, I have to say, given everything else, and IG has been holding up pretty well, we know that the consumer and corporate balance sheets came into this as a position of strength. You know, we've obviously seen some hiccups in lower credit quality. But just in terms of where do you see the opportunity, or how has your market reacted for the volatility and some of the opportunities you see going forward?

Yeah, thanks, Leslie. So it really has been a dampener in terms of total return. So you look on a year-to-date basis, and price returns are about flat for an index of investment grade corporates.

You've had a widening of credit spreads of about 30 basis points, but that's been offset by lower coupon treasury yields there. But what we've seen is really decompression occur within investment grade credit. So evidence of this is, you know, sectors and areas that were really tight have really moved the other way a little bit.

And you can see this if you look at the difference in spread between BBB corporates and Single A. You know, that's widened out to about 44 basis points, and that's like the widest that we've been since 2023. If you look at industry sector moves, we've certainly seen more cyclical sectors widening more so than defensive sectors, especially after the April 2nd tariff announcement day.

So since then, we've seen sectors in investment grade credit like autos and energy experiencing more significant spread widening than defensive sectors like utilities and telecom. Incidentally, you know, more of those cyclicals do have higher tariff exposure as well. So that's been coming into play.

So you're seeing some, you know, decompression dispersion there. And then the third area is when you look at banks, which are, you know, a significant portion of the investment grade corporate bond market, almost about, you know, a quarter of the market by index weighting. If you just look at the differential in spreads between senior and secured bank bonds and subordinated bank bonds, you know, this is has increased.

It's currently about 37 basis points, but was in like the mid 40s a few days ago. And what's really interesting here is that, you know, that differential actually exceeds what transpired back in March of 2023, when you had the, you know, the regional banking crisis episode. So we're, you know, we're back to levels of like late 2020, 2021, in terms of this senior and secured subordinated spread.

I think that pertains to the environment where we're in, where, you know, it's really the more of a macro growth, slowdown, earning slowdown type of, you know, risk environment that we're in rather than something specific to a certain sector like banks. So, you know, because it's more of this macro effect, I think, you know, again, and then with this decompression trends that we're seeing, that's why that senior subordinated relationship has widened to the extent that it has. You know, you're also seeing the effect on supply demand technicals and investment credit.

So certainly there was some issuance gaps that we've witnessed the week of April 2nd to the 11th. There was only about five new issues that came to the market. That's since reversed, though, this week in particular has been quite active.

Four of the six, about big six U.S. banks have come with primary deals this week. So, you know, clearly a reopening of the primary market, you know, so we think it is functioning well. And the pause that we saw was more, you know, issuers just waiting to get days of lower volatility, better execution, more so than anything that would signal, you know, the market being shut.

You know, demand, obviously for these primary deals, you know, demand has been still solid. You do see demand that is more a little concerning as it relates to fund flows, because there's been like record outflows really from a lot of categories of fixed income funds, even high grade, where you had about $9 billion withdrawn from funds last week, which was the fourth largest on record. But we think that that pertains more to just the negative total return, you know, over a short period, over a one or two week period, you know, more so than investors really bailing on the asset class.

So, you know, altogether, you know, as we kind of just assess where things are, it's really the same kind of assessment that we've had, you know, coming into the year where the main value and investment grade is more from that yield that you're getting, which is in kind of that low to mid 5% range, rather than spread, you know, because again, where we are in spread at about 113, 114 basis points, still kind of in the low end of the range that you typically see even in non-recessionary periods. So, you know, pretty, you know, fair to tight in terms of the spread environment, but still attractive from an absolute basis. And the fact that we did see that dampening effect occur, you know, this month, I think bodes well.

And something we think, you know, we should continue going forward, where if you really did have more of like a growth scare type environment risk off event, you know, that caused a flight to quality and treasuries, then, you know, we think that, you know, IG corporates could, you know, stand to benefit from that duration. And, you know, their spreads, yes, they would move wider, but not by the extent that you might see. And, you know, some are the more credit sensitive areas within credit.

I can turn it back to you, Leslie. Yeah, absolutely, Barry. I think you touched on something that you just reminded me of that I think is really important is that, yes, I mean, as you mentioned, you know, IG spreads can be 110, 113, you know, but from a historical perspective, if you look over the past 25 years, it's still really tight.

It's just the point that they started at 80 or 78, the same goes for the high yield market. So one of the things that we're seeing now when people look at the widening spread, it's that delta that's really large, big, right? Because we started at the same level, but as an absolute spread level, it's not as though you're even close to, you know, not that we think that we're going to get a recession because we don't, but those levels.

So, you know, spreads overall, yes, wider, but I think the point is, and the point you're trying to make as well, is that that delta is just so extreme in IG and high yield that it looks as though you'd think these spreads would be historically very wide, but they're not, right? They just started very, very tight. I think that's an important point to make.

So thank you for that. I want to shift over now to Sadiq and the municipals. And, you know, Sadiq, we know municipals have been a fan favorite for buy-side accounts for, you know, a really long time because they've offered relative value.

But munis, like agency NBS, they can't seem to get a trend going that lasts for a period of time, and there's always some sort of hiccup in the market, whether it's vol or supply or, you know, whatever the performance driver might be that's a headwind to overall to the return. So I'm just thinking about how are you viewing this volatility? Where do you see the opportunity going forward?

Sure, Leslie, and thanks for having me and very well described about those episodic events in munis. So really, just to recap performance, munis experienced a sharp, sharp sell-off since the tariffs were announced on 2nd April. Then the red and significantly underperformed most other fixed income assets probably except the first.

Yields have literally surged higher across the curve, and volatility actually spiked to levels last seen during the pandemic. So it's a fairly severe event, although munis volatility is typically lower than Precious and IG Corporates. This time it has been far more volatile, and we'll just come in a minute as to why that is.

And also, although munis are typically buy and hold for the most part, they see this intense selling occasionally of high quality munis bonds, and that was what happened this time, and funds are now reporting ETFs and mutual funds, significant outflows. So in short, this sell-off was driven by a combination of three factors, rates volatility, weak muni technicals, and increased policy anxiety. But before getting on those three things, I should add that something that Frank mentioned, munis yield were actually increasing even when Precious were falling.

Typically, they are fairly correlated with Precious yields, but not this time. They have risen in tandem after the 2nd of April as Precious yields rose, but in March, they were rising because of these weaker technicals. March is typically a weaker month, and this year particularly has been weak, as supply is running really hard, even compared to last year, which saw record issuance.

So we do expect these technicals to improve after May, as these coupons kicking, reduction demand increases, and making demand supply come into better balance. But until then, technicals do remain challenged. So overall, this has been really akin to a market dislocation.

As in the municipal market guide we pointed out, dislocation also brings opportunities. Volatility is unnerving, especially for investors who don't expect this volatility from a safe fast class. Just munis is pretty disappointing, but it does bring opportunities.

Longer maturities, given their tax equivalent deals, steeper slope, cheaper relative valuation, there is higher MT ratios. All of that is supportive of longer maturity bonds. That said, because these near-term technicals being challenged, our preference still remains for a volatile strategy, 4 to 8 years, and then 7 to 30 years in the curve.

And then so far, we haven't seen this sell-off was really rates, technicals, and policy. Not about credit concerns. But from here, we actually have a strong preference for high-quality bonds and defensive sectors.

That is just because economic growth might slow in a sharp slowdown, given tight spreads, triple Bs, high-yield spreads can widen substantially. So we prefer high-yield bonds, and we prefer defensive sectors, sectors like state geos and electric utilities. Those are in solid shape.

Overall, despite credit valuations notwithstanding, fundamental credit quality remains pretty stable. In the long run, that's what investors care about. Default rates will continue to be low, and credit quality generally, given high state rainy day fund balances and other sectors having pricing power, should remain fairly resilient.

So that's what our outlook is. And one last comment on policy. Policy worries really escalated after the 2nd of April, as investors started to worry more about extreme outcomes with regard to tax exemption after the tariffs were announced.

And a lot of rumors in the market that will totally go away, or caps being put in place which would destroy wealth. And we continue to believe that some types of munis, such as higher education sector, private activity bonds, could lose their tax exemption, but their existing bonds will be grandfathered. Recently, bipartisan support for the tax exemption seems to be growing, which is good news for munis.

And there's even talk for a top tax bracket, which also would be good news if implemented. But policy remains pretty fluid. We may be past peak uncertainty in tariffs, but as the reconciliation bill moves forward, we will get more color on this probably by June.

So overall, I think I would say it's been a market dislocation. It has gotten in opportunities. We like higher quality.

We like longer maturity, but barbelled with shorter maturities. And we like the defensive sectors. So let me put it back to you, Leslie.

Yeah, thanks, Yusuf. That was a great, you know, synopsis. And I think what we can all take away from this is, you know, look, the high level of uncertainty and the shock to the market, if you will, given some of these tariff policies, the duration and the depth and the reciprocal is just obviously something the market was not expecting.

I think it's important to remember that, you know, with this underperformance, fixed income is not the leader. It's the follower. Equity is the leader right now.

And so the fixed income assets are really fixed income in general is really following the equity market. I think a lot of our panelists talked about, you know, the yield that you're getting. And I think it's an important point with that is even when treasury yields went down, you know, those sectors that have a nice interest rate risk started to produce negative returns, simply negative price returns, because their spreads widened.

So even though interest rates are lower, the yield that you're getting is greater because spreads are widening. But remember, with the spread that's widening right now is not something that is signaling that we're going to, you know, that there's credit deterioration, that there's overly leverage, that, you know, these corporations have, you know, poor balance sheets or any of those types of episodes that we've seen in previous bouts of financial volatility. This is not the case this time.

And that's why we believe that going forward, when we have a little bit more stability, a lot of these asset classes are very attractive in terms of yield, you know, and spread. So, you know, we'll be back in the month after next. And I'm sure at that time, the narrative will completely shift once again.

But we look forward to catching up with you then. So thanks so much for joining. Thank you for tuning in.

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