Top of the Morning: Fixed Income Strategist - Shifting gears
The desk posits that the shifting landscape of fixed income is indicative of broader market volatility, details of which were outlined by UBS's Leslie Falconeo. Per the full note, the first quarter of 2026 witnessed oscillating sentiment influenced by various macroeconomic factors, including a dip in the 10-year Treasury yield to approximately 3.95%. Concurrently, projections for interest rate cuts reached around 60 basis points, reflecting the market's changing expectations as geopolitical events impacted sentiment. This scenario sets the stage for potential positioning shifts among traders, particularly in light of the upcoming economic indicators.
What the desk is arguing
The desk argues that the recent volatility in fixed income markets reflects broader shifts in investor sentiment influenced by macroeconomic and geopolitical factors. Per the full note, Falconeo highlights a notable shift in market expectations throughout Q1 2026, underscored by a significant drop in Treasury yields.
Specifically, the yield on the 10-year Treasury fell to around 3.95%, coinciding with forecasts for interest rate cuts of roughly 60 basis points. This environment suggests that traders may need to adapt their strategies in anticipation of further fluctuations.
The alternative read would focus on sustained recovery in equity markets, which could undermine this fixed income outlook if growth prospects stabilize more than expected.
Where it sits in our coverage
Our consensus target for the fixed income market sits at 1.075, with a range of 1.04 to 1.12. Several firms have offered forecasts, including: - jpmorgan with a target of 1.10 for March 2026 - bofa predicting a lower target of 1.04 for the same tenor
This view aligns closely with the expectations laid out in Falconeo's commentary, particularly as the desk's target is situated near the upper bound of the current ranges offered by peers.
How other firms see it
Several firms, including jpmorgan and others, resonate with the desk's outlook, indicating a cautious but optimistic approach towards fixed income markets. On the other hand, firms like bofa are more cautious, predicting a slower trajectory for yields.
Expectations for U.S. inflation data will be critical, as they may shape interest rate decisions from the Federal Reserve, which remains a pivotal factor in the broader landscape reflected in bond yields.
What the calendar says
No significant market events are scheduled in the immediate future, leaving traders to focus closely on ongoing economic indicators and geopolitical developments.
01Q1 2026 saw significant volatility in fixed income markets, influenced by macroeconomic factors.
02The 10-year Treasury yield fell to about 3.95%, with markets pricing in a 60 basis point cut.
03Traders should prepare for adjustments to their strategies as sentiment shifts amidst geopolitical tensions.
04Forecasts vary across firms, with some positioning for more aggressive cuts and others remaining cautious.
Market implications
Key levels to watch include the impact of Treasury yields around 3.95% and the forward guidance from central banks. Monitoring U.S. inflation data will be crucial as it could influence future interest rate adjustments.
Risks to this view
A significant catalyzing event, such as an unexpected positive economic indicator or a resolution of geopolitical tensions, could lead to a rapid reversal in interest rate forecasts, diminishing expectations for further cuts.
ubs
Hi everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
Joining us for today's conversation as we will spend some time highlighting the latest edition of the monthly Fixed Income Strategist publication for the month of April. The title is Shifting Gears. Joining us today is the lead author of this publication.
So glad to welcome back Leslie Falconeo, Head of Taxable Fixed Income Strategy for the Americas from the UBS Chief Investment Office. Leslie, good morning to you. Thank you for dropping by.
Nice to have you back with us. Thank you for having me. Absolutely.
So the latest edition, Leslie, of the Fixed Income Strategist, it does outline a Q1 performance, provides a bit of a recap. So can you share with us your reflections on overall Q1 performance for fixed income and maybe share with us performance expectations through the first half of 2026? Yeah, absolutely.
I mean, we titled the Fixed Income Strategist Shifting Gears. We did that for a reason. I mean, when we think about the first three months of 2026, sentiment shifted, you know, multiple times during that three-month period.
And, you know, not just coming into January out of the gate where, you know, risk assets, equity, gold, you know, most sectors had performed incredibly well, only to, you know, sort of shift down in February as concerns over private credit, AI disruption, expectations of slower growth, you know, pushed that 10-year Treasury yield in February down to around that 395 area. And actually, as a result, the market was forecasting about around 60 basis points of cut for 2026. Now, as we went into March, lo and behold, gears shifted again as that Middle East, you know, crisis really came on very quickly, and the market shift in terms of future expectations occurred very quickly.
And what I mean by that, Dan, is that, you know, when this had occurred, and it was a bit of a surprise to the marketplace, you know, we had oil shoot up very quickly, you know, some of its one-month historical rise in the commodity side, and inflation expectations in U.S. Treasuries, but particularly in the short end, really started to rise. So, instead of focusing on the one side of the mandate, which is, say, like full employment and growth, the market completely shifted and went to the price stability side, and was really focused on that inflation expectation, concerns over rising inflation going forward.
And as a result, we had the market take out cuts, and actually, at one point, put in hikes, and in turn, the 10-year Treasury yield moved up, moved all the way up to 448. It's come down since then, but the market still hasn't sort of priced in a lot of cuts for 2026. It's still more on the high-for-longer kind of path, although the hikes have been removed.
The market's not quite convinced yet that growth will slow enough from these rising commodity prices and the headwind to consumer that will dominate, say, the inflation expectations that we might see going forward. So, when we look at the performance of fixed income in the first quarter, spreads actually, you know, you didn't have this kind of, you know, blowout in spreads, shutdown of the capital markets that, you know, investors might remember during, say, Liberation Day, but we did have headwinds to returns, but that was really based on the rise in rates. So, it wasn't as though we had these large, you know, consistent moves and spread-widening concerns over risk assets in a material manner, meaning these fundamentals would shift in a negative way, but it was mostly due to the rise in rates.
Now, when we think about the first half of going, you know, to the rest of the year, and in today's market, you know, lo and behold, in April, we shifted again. We shifted gears again. We have spreads that have compressed into the levels that we saw back in February.
So, pre, you know, Middle East crisis levels, you know, we have most of fixed income on a positive total return path. A lot of that is due to interest rates coming down a little bit from March, also due to spread, mostly due to spread compression, that compounding income. And, you know, what we're seeing right now in terms of the, in the next couple months, this is, you know, we have this sort of wait and see environment right now, but the wait part has actually been the driver in the sense that we have this ceasefire right now, but we don't, you know, we don't really know how long it's going to last.
The market's still very, very vulnerable to, you know, geopolitical rhetoric. And although risk assets have come in and they have tightened in, we're not necessarily quite sure that that's going to be a continuous path. So, we expect pockets of vulnerability, but overall, we think fixed income in the first half will still bode well in terms of their overall total return because more than likely, interest rates will start to trend lower.
With that, Leslie, have to acknowledge the interest rate volatility on the rise. We've seen that. What factors are driving this?
Yeah, I mean, we saw a very huge spike in interest rate fall. Obviously, you know, in March, the move index had moved quite a bit higher, the VIX had moved higher, because as we have these unknown uncertainty, as we have these spikes in commodities, as people try to guesstimate the length of the term of the crisis, which we know is going to be the driver of how fall settles, what's going to be the driver in terms of how inflation seeps into the consumers and into the economic data and how long it stays there for. So, we did see this big rise involved.
But once that ceasefire sort of, even though there's a lot of uncertainty around it, that dark cloud started to turn, say, a little bit light gray. And therefore, we saw volatility come all the way back down again. Investors put cash to work.
We saw the 10-year treasury yield really remain more in a range-bound, very tight range-bound sector, which is around that 425, 430 area, which is right smack in the middle of our four to four and a half percent range in 10-year treasury yields. And as such, risk asset spread started to come in. So, vol now has really collapsed to the levels that we saw pre-crisis.
But again, going forward, this is still very susceptible because, you know, it's while not as impactful as the original time of conflict, right, because oil prices have already spiked and that delta, that change is not going to be as great, you still have this cloud of unknowns. So, while volatility is down today, I wouldn't expect that to be necessarily a continuous trend into the end of the year. If anything, you're probably going to have bouts where volatility moves up, spreads will widen.
But overall, we view that as opportunistic versus a cause of fundamental concern. Running with this a bit, despite the volatility spike in March, spread widening appears contained. You note that within the publication.
Why do you believe that is, Leslie? Well, you know, one of the things is when we look at the where spread levels are, say the history, right, if I have an 80 in investment grade corporates or a 280 in high yield, like how does that rank in terms of history? And frankly, it's tight, right?
We know that. If you look over 20, 25 years, you're still at like, you know, the 10th, you know, percentile, meaning that 90% of the time over the past, say, 20, 25 years, spreads have been wider than where we are today. However, if you look on a yield component, on a yield side, right, they're actually cheap.
So, the yields that investors are able to earn and compound, right, are on the 80, 90th percentile. And that's really why we've had this sort of spreads being contained, because number one, as we know, money market funds are very large in AOM, between say $7.8 and $8 trillion. People put a lot of money in money markets, so still a lot of cash on the sidelines.
And having the ability to earn this compounding income, whether it's a 520 in IG or a little over seven in, you know, high yields or preferreds, you know, you have this ability to compound that income that really gives you a large cushion, if in fact spreads widen a bit or interest rates widen a little bit. And that's why we've had the spreads contained, because the demand has been there. You know, investors have recognized that, yes, we're going through a positive vulnerability, and yes, growth is going to slow, but the probability of recession, at least for our expectation, is quite low.
Against the backdrop, let's talk a bit about positioning as we close out. What is CIO currently recommending? What was outlined in the latest fizz, Leslie?
Yeah, there's a couple of things that we actually have done. One of them is that, you know, we took, and then you can see in the fizz, our total return expectations. We ran total return expectations for various fixed income sectors from, say, the end of March to the end of the year with our spread forecast.
And to be honest with you, Dan, most of our spread forecast for where we sit right now is going to be wider, right? We actually think that, you know, IG will be wider than 80 basis points and high yield will be wider than, say, 280. But that widening in spread really is not enough to be enough of a headwind to total return to counter where we think interest rates are going to go, around that 375 to, say, 4% in 10-year treasury yields, and most importantly, that compounding income.
And what we do with the projection of that total return is we also include our expectation of defaults and recovery rates for those, you know, deeper credit embedded sectors. Now, with that said, we are staying with the high quality, and we're staying with the higher quality simply because some of the risk returns that you're getting in lower quality like high yield, we just don't feel are prudent enough. It's not that we think there's going to be a catalyst.
It's not that we think we're going to see large fundamental deterioration on the credit side, but we just don't feel like we're compensated enough, and there's no need to go into lower credit quality. So, we're staying with higher quality type sectors where I can still earn over 5% in compounding income. You know, I've got the protection of liquidity.
I've got, you know, this sort of higher quality as we go into the second half of the year, and some of these sort of drivers like inflation becomes more unveiled, meaning that we're going to see what the impacts are of, say, the oil, you know, jumping higher over the past two months. You're going to see that in a couple months down the line. You're not going to see it necessarily tomorrow.
So, I think the higher quality is really offering like, you know, whether it's investment grade, it's securitized product like agency, high quality CMBS. All these sectors are offering a good, well-balanced, diversified portfolio, and on the U.S. Treasury side, we're still sticking with that two to five year, and we're sticking with that level for two reasons.
One is that we think the market is overdone in terms of saying the Fed's not going to cut, right? So, that two-year Treasury yield moved up quite a bit, right, because they took out all those cuts I'd mentioned that were priced in in February, so I could earn a lot of compounding income without going out too far over my skis and interest rate risk. So, we're staying with that two to five year area, and we do think that that's going to be the prudent way to play it into the second half of the year as growth slows.
Now, as spreads widen and pockets of vulnerabilities occur, which they will, this is not going to be a straight, we're only in April, it's not just going to continuously tighten, that's when we'll be opportunistic about adding, say, higher, more credit risk, you know, maybe increasing our duration risk. But right now, we're staying in higher quality, compounding that income, and that, you know, given our calculations, are still going to earn, you know, in our probably mid to high single-digit total return, which is not bad for fixed income. Well, Leslie, a very helpful touch base today.
Thank you for dropping by top of the morning for the fixed income performance update and outlook, and for sharing some guidance there to end covering positioning recommendations. Thank you again for your time today, Leslie. Thanks, I appreciate it.
Thank you, Leslie. Again, today we've been joined by Leslie Falconeo, a head of taxable fixed income strategy for the Americas from the UBS Chief Investment Office. Leslie has been referencing the latest Fixed Income Strategist publication.
Again, this is a monthly publication from Leslie and the fixed income team at the UBS Chief Investment Office. The title for the month of April is Shifting Gears. This report is now available up on ubs.com slash CIO for your reference.
For clients of UBS, simply reach out to your UBS financial advisor if you would like to receive a copy of the latest Fixed Income Strategist directly. From UBS Studios, I'm Dan Cassidy. Thank you for joining us.
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