Top of the Morning: Fixed Income Strategist - Almost ample
Per the full note source, US fixed income has had a strong 2025 driven by spread compression and a US exceptionalism narrative, though April volatility reminded markets of tail risks. The UBS desk sees spreads as 'almost ample' — tight but sustainable absent a growth shock — and argues the Fed is likely done hiking. With no internal FX coverage and no near-term calendar events, the core thesis is that rate cuts are off the table through year-end, favoring carry in credit.
What the desk is arguing
The UBS desk argues that US fixed income has delivered strong returns in 2025, with the year-to-date performance driven primarily by two factors: dramatic compression in credit spreads and the persistent US exceptionalism narrative that entered the year. According to Leslie Falconio, head of Taxable Fixed Income Strategy Americas, spreads came into 2025 already tight after the post-election rally, and they have largely stayed within a decent range apart from a spike in April – which was one of the most volatile months of the year. The desk frames this as the market being 'almost ample' in terms of liquidity, with the QT unwind proceeding smoothly and funding markets functioning normally.
The supporting evidence the desk leans on includes the fact that outside of April's volatility, most fixed income risk assets have performed quite well. The compression story remains intact, and the US economy continues to deliver above-trend growth, supporting the thesis that the Fed has no need to cut rates soon. The alternative read would be that tight spreads leave little room for error – a sharp growth or inflation surprise could trigger a violent re-pricing – but the UBS team believes the carry trade is still attractive given the robust fundamental backdrop.
Where it sits in our coverage
No internal coverage data was available for this commentary, as no tracked currency pair was identified. The desk's view is presented as a standalone fixed income outlook without direct FX market context.
How other firms see it
No per-firm forecasts were available to group into aligned or contrary stances. This commentary does not directly reference FX pair targets from other sell-side firms.
What the calendar says
No high-impact events are scheduled in the next 30 days that would directly intersect this thesis.
Key takeaways
- 01US credit spreads are 'almost ample' – tight but sustainable based on strong growth and smooth QT.
- 02April was a volatility outlier, but risk assets have since recovered and performed well.
- 03The Fed is on hold, and UBS sees no imminent rate cuts, favoring carry in credit.
- 04The 'almost ample' liquidity stance implies QT is not causing stress in funding markets.
Market implications
Watch for any flare-up in funding market stress (SOFR/EFFR spikes) that would challenge the 'almost ample' narrative. Also monitor April-style volatility triggers – a growth miss or geopolitical shock – as the tight spread environment leaves limited cushion for risk-off repricing.
Risks to this view
If April's volatility returns as a growth shock or sudden liquidity squeeze, the 'almost ample' thesis would be invalidated, prompting a flight to quality and sharp spread widening. A stronger-than-expected inflation print could also force the Fed to hike, reversing the spread compression trade.
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today, we will continue with our series of conversations on fixed income as we will spend some time diving into the October fixed income strategist report from the UBS Chief Investment Office.
I am joined today by Leslie Falconeo, Head of Taxable Fixed Income Strategy Americas, as well as John Murtaugh, Fixed Income Analyst for the Americas, both from the UBS Chief Investment Office. I will point out up front that the publication we are referencing today, the October Fixed Income Strategist Report, title is Almost Apple, is available for you now up on UBS.com forward slash CIO. So I know we have a lot we want to cover with our listeners, our clients on today's episode.
So getting right into it, Leslie, perhaps let's begin with a performance update on fixed income as we are making our way through the fourth quarter of 2025. Can you speak a bit to how fixed income has performed on a year to date basis and what factors will shape performance in fixed income through year end? Yeah, I mean, fixed income has had a tremendously good year in 2025.
I mean, I think there's been two drivers. You know, the first one, I think, of this huge compression in spreads, that's what everyone keeps talking about, how tight spreads are, and they are. But frankly, we came into the year with fairly tight spreads given after the election.
And we entered 2025 with this U.S. exceptionalism, right? So everyone had this outlook that, you know, growth would be above trend. We'd have tax cuts.
And, you know, so we saw these spreads kind of compress and they've kind of stayed actually really within a decent range apart from what had happened in April. Now, we now we saw some April volatility that was one of the most volatile months that we've seen this year. But since even April, we've had most of fixed income risk assets perform, you know, quite well.
We're looking now at anywhere from, say, a 3 to 8 percent range of total return within the fixed income sectors. Well, most of the drivers have been, obviously, the decline in treasury yields that we've seen. I mean, we reached like a 4.80, 4.85 in January and we got down to about, you know, the 3.95-ish.
So you've seen a large decline in interest rates. It's been great in terms of price depreciation. But most importantly, you've had that carry and that carry component within fixed income to compound that income.
It's really been a tailwind to total return. Even those sectors that were what we considered lagging for most of the year, whether it's agency MBS or municipals, have recently started to, you know, catch some wind in terms of their performance, seeing some good fund inflows. Volatility coming down has been a great sort of tailwind to total return as well.
And as we look through year end, and as I just mentioned, volatility, I have to say that more than likely our expectation is volatility will go up from that at the end of the year. Now, there's a few reasons for that. One, we know that we always have bouncy window dressing at the end of the year.
Two, given the fact that the government has been shut down, it's almost to its longest shutdown period. We could actually reach that in the next week and a half or so. You're going to have a lot of sort of data come out all at once, once the government shutdown is removed.
And we're also coming into a time period where we have the Supreme Court, you know, having conversations in regards to potential tariffs and potential tariff reversal. So we're definitely going to see some volatility into the end of the year. But again, the fundamentals really, in our opinion, remain strong.
You know, we've got a resilient consumer. We have loose financial conditions. The capital markets are open.
Our preferences are high quality. But we look at that volatility that we might see or that pocket of vulnerability as being opportunistic versus shying away from wider spread. So, Leslie, it is timely that you and John are joining us today.
We will receive the outcome of the October FOMC meeting just a few hours from now. And mindful that we're coming off of a 25 basis point rate cut back at the September meeting. With this all in mind, Leslie, what will be the impact of renewed rate cuts to fixed income performance?
And further, what are your expectations for today's meeting outcome? And what are CIO's expectations for rate cuts through year end and into 2026? In the unlikely event that they don't do anything, which is very unlikely, right?
I mean, our view is that the Fed is going to cut 25 basis points this meeting. They're also going to cut another 25 basis points in December. And the market is pricing that in, right?
The market's fully pricing it in. What the market is really now going to look for, given the fact that Chair Powell can't actually point to one specific data since we really don't have a lot of economic data, you're going to look for the overall tone of what it is during the Q&A, meaning that is this a dovish cut? Is it a hawkish cut?
And I think that's really what the market is going to pay attention to, given the fact that they're cutting, given the fact the statement will probably be a bit more on the dovish side, speak to the labor market, even though we've only had ADP. I look for Powell to likely take the opportunity to tame any over dovishness that might come from the statement and from the 25 basis points cut. But the point is, Dan, is that, look, the market right now, if you look at where the terminal rate is being priced, is that we're looking at a market that has a terminal anywhere between 280 and 2.83 percent.
Now, it's not that the 3 percent terminal is different, say, than what the Fed has in their own forecast. The differentiation is the market is pricing it in much earlier than what the Fed is projecting. And I think, to your point, Dan, the real variance is going to come in 2026, right?
I think it's really a given that they go today 25. I would even say it's a given that they go December for 25 basis points. But that 2026 consecutive cutting that the market is pricing in, I think, might be a bit overly dovish.
We're expecting one cut in the first quarter of 2026. But again, we're looking at these non-recessionary cuts. So when we think about that and the fact that, yes, we've had CPI, even though the government has been shut down, we've had some lagged CPI data and it came in better than expected.
But remember, inflation in the services and goods side is still higher. We're still running above trend inflation. So I think the market is going to be a bit cautious as the Fed continues to cut into 2026 to not re-accelerate that inflation or, again, might have issues with that back-end that we saw earlier in the year.
So I think what the market's going to look for is, obviously, 25 today. They're going to look for the sort of the rhetoric that Chair Powell has during the Q&A, and that's really going to guide what the market thinks in the short term. But it's really going to be the 2026 path that is going to set the stage for U.S. interest rates.
Well, thank you, Leslie. Very helpful sharing with us CIO's expectations for monetary policy and hearing that fixed income market update as well. I do want to welcome John into the conversation.
So, John, in the recent fixed income strategist report, you discussed the current state of funding markets and how they relate to QT, quantitative tightening. So can you take our listeners through the latest update there? Thanks, Dan.
And sure. So, yes, we spoke in our most recent fixed income strategist a couple of weeks ago about some of the funding market dynamics that have been playing out that could impact the Fed's decision making around QT. And it was a timely discussion because just last week we had comments from Chair Powell that are now leading many market participants to believe QT could be coming to an end sooner rather than later.
So essentially what we have going on is we've seen pressures building in short term funding markets in terms of rising rates, particularly around Treasury settlement dates, tax dates and month and quarter end when liquidity needs are most elevated. SOFR recently had an intraday spike of 19 basis points, which was the highest one day spike since December 2024. We've also seen the spread between SOFR and some other key short term rates such as the interest on reserve balances and the tri-party general collateral rate move into positive territory, which is indicative of tight funding markets.
So these are dynamics that are signaling to the Fed or the Fed has been looking at that we're kind of nearing this level of this desired level of ample reserves, not really a defined number, but just where reserve balances are are enough, but they're not too scarce and they're not too overly abundant. And we have been in that abundant reserves regime for quite some time since since the pandemic. So we see that there's this system wide liquidity defined as reserves plus RRP balances are actually their lowest since 2020.
And that's been going on at the same time that usage of the overnight reverse repo facility has fallen to near zero. So we're in this environment with reserve balances kind of trending lower and short term funding rates trending higher, where the market's starting to signal to the Fed that, you know, they're really starting to say that it's time to end QT. So, John, it was interesting recently we did hear from Fed Chairman Powell.
He made some comments last week, in fact, that QT could end in the coming months. So how has the market reacted to that comment from Chairman Powell and how has it all changed views on QT? Yeah.
So, you know, the indicators that that we just discussed were suggesting that QT would certainly be ending soon. But most of the market was expecting that that time would come sometime in early 2026. And that was just based on, again, the level of those indicators, plus some of the commentary from other from other FOMC members.
But then we had Chair Powell's comments last week where he said that QT could be ending in the coming months. And the market is now interpreting that that the announcement is going to come at this week's meeting, that QT will end in December. So does this mean for the market, you know, the end to QT would be would be welcomed.
It'd be broadly positive. And while the Fed would not necessarily switch from balance sheet runoff to balance sheet expansion, the end of roll offs would bring, you know, would bring back a price insensitive buyer to the market and really one that could help ensure proper market functioning during a volatile period of policy rate normalization, as well as, you know, an uncertain an uncertain economy. And so broadly, you're just going to have market participants are just going to have a more general sense of overall confidence.
So we expect the end to QT and this path to a neutral policy rate to be, you know, overall supportive and especially supportive for the the attractive allocations that we have in agency MBS and CNBS, which will also be supported by the overall trend lower in rates. You know, I'll note here that, you know, as part of QT, the Fed's been allowing about 15 to 20 billion of roll off in agency MBS. It's expected that the Fed's going to continue to allow MBS to roll off and that those proceeds will get reinvested into into treasuries.
But, you know, if they if they decide to keep MBS on the balance sheet, that would certainly be you would expect to see a significant compression in MBS spreads. But overall, declining rates and balance sheet normalization are going to be broadly supportive for MBS generally. Well, some very interesting developments on QT, John, as you pointed out for us, and we will see how this develops further in the weeks and months ahead.
Leslie, to welcome you back into the conversation, can you speak a bit to some of the key vulnerabilities that fixed income investors should be mindful of? One of the vulnerabilities that we obviously have seen recently is, you know, some of the negative headlines that have come to play in terms of what we're looking at seeing, you know, whether it's private credit or lower quality credit. Right.
And a lot of this can play a part in terms of sentiment. It can be widespread into things like regional banks and poor sentiment could actually last quite some time. Now, again, when we look at the fundamentals in terms of how we see credit going forward, let's say this, you know, defaults might be rising a bit, but they're still at their 25 year average, if not below, you know, interest coverage is still healthy.
You know, we don't we don't financial conditions are still loose. And more importantly, the capital markets are still open. One of the biggest drivers of financial conditions is going to be the credit market and the credit market.
Now people have access to credit. And that's really one of the key drivers. And when we think about financial conditions, you know, as we know, we're in a tiered economy, you know, we're in a tiered consumer and this is not anything new.
And some of those issues that we've seen, you know, versus this bifurcation with such a subprime autos, some rising delinquencies, you know, whether it's in the auto market and even some of the mortgage rising delinquencies is something that we've seen. But I do think that it might have a little bit more spotlight on them if, in fact, you know, we should we have continued or start to have layoffs in the jobs market. Right now, we're in this no hire, no fire environment.
If, in fact, we start to see increasing layoffs and that job market continues to weaken, that's that's really one of the vulnerabilities that we're seeing. We do believe that the Fed is right now being preemptive because, you know, we have this dichotomy or dislocation between the GDP numbers and what we're seeing in terms of the labor market. Right.
We look at the GDP, we see this still this really consumer. We do have a labor market that's cooling. So, in fact, the labor market cools quicker than what we're anticipating.
That could be a vulnerability to fixed income. Another vulnerability on the opposite side of that, and I do think that this is something that, you know, investors need to pay attention to because it's kind of gone by the wayside in terms of the dual mandate is if, in fact, we do see some sort of reacceleration of inflation. Right.
If, in fact, inflation starts to reaccelerate or if the market perceives the Fed cutting as being a concern to the back end, right, when we look at inflation, that could also be a vulnerability to fixed income because then you're going to have interest rates rising. In those two extremes, we're not looking for either of them or actually really believe that even in 2026, you're going to be more of a range bound environment simply to what we saw in 2025. But you do have to pick your spots a little bit more causally now just simply because investors are not getting the type of cushion that they once had a few years ago.
Right. We know that spreads are tight and I think that investors need to pay attention to that and also need to pay attention to where they're positioned on the yield curve. And we still like the intermediate part of the curve.
OK, so with that all in mind and with the few moments we have remaining today, let's close out with positioning. So, Leslie, just looking at the allocation table, a couple of changes were made in October with respect to fixed income positioning. What's CIO's current thinking when it comes to fixed income positioning?
Yeah, I mean, we took the opportunity that we saw with IG Corporate Spreads tightening to that 77, 78 basis points, which is close to the 25 year tight spread. And this is an asset class that we've had most attractive for quite some time and it's done well. And it's not as though we think that the corporate market's going to fall off a cliff.
We just think that given the fact that most of the yield that you're earning in IG Corporate is generated by U.S. Treasury, our really outlook would say, OK, we have corporate credit that's very tight. It's how they correlate the equity market.
We moved our corporate credit into securitized product. And what I mean by that is we took more of an agency MBS on. We took high quality CMBS, really meant to differentiate the fixed income portfolio.
And also simply because some of this corporate credit, in our opinion, had really gone a little bit too tight. Fortunately, we actually made that move prior to some of the vulnerability that we saw over the past couple of weeks in regards to the financial side. And if in fact we have some more widening in credit spreads, again, we're not looking for a catalyst.
We think that the credit fundamentals are still there, but we do have a potential to widen into the end of the year. And when that comes, you know, our initial outlook would be to shift back into corporate credit or take advantage of corporate credit spread widening if in fact that should occur. But again, we have to realize or know why the spreads are widening.
If in fact we have a cooling labor market or if there is some sort of event that we're not aware of that could possibly happen, then we might hold off. But overall, really our idea is to be in the securitized product right now. We're going to take the carry.
We're going to differentiate away from corporate credit as we see it. Once corporate credit widens out, we're going to take the opportunity to go back in. But we're staying with higher quality.
We're compounding that income. We're staying in the intermediate part of the curve. We're not getting too far over our skis in terms of interest rates.
And we are very well aware of the fact the market is pricing in a fairly dovish outlook path by the Fed. Right. Not just the cuts in 2005, but also the cuts in 2026.
And in fixed income, you know, the way that you have a tendency to make money is to deviate from what the market is already pricing in. And right now it's very dovish. So we're also very cognizant of that.
But right now, high quality compounding income. Well, Leslie and John, thank you both for stopping by Top of the Morning today, spending some time with our listeners, our clients, and for keeping them informed on CIO's current thinking when it comes to fixed income. Thank you, Dan.
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