Themes, outlook, and investment implications across global fixed income markets
Principal Fixed Income
Fixed income perspectives
Selective strength in a policy-driven market
As the Federal Reserve cautiously progresses through its rate-cutting cycle, fixed income markets are being reshaped by a sharp shift in policy dynamics. The implementation of broad-based tariffs and rising geopolitical uncertainty have added new macro headwinds, intensifying volatility and clouding both inflation and growth expectations. Despite the evolving backdrop, elevated yields, improving valuations, and strong underlying credit fundamentals continue to make fixed income a compelling opportunity.
U.S. outlook
The U.S. economy enters 2025 as a standout performer globally, demonstrating remarkable resilience despite headwinds. Robust consumer spending continues to drive economic growth, supported by historically elevated federal deficit spending, strong wage gains, and wealth effects from stock market gains and stable housing prices. While the labor market is gradually cooling, with higher unemployment rates and slowing hiring, layoffs remain limited, pointing to measured adjustments rather than sharp downturns.
Inflation has shown signs of moderation, particularly in shelter and goods prices, but some services sectors remain stubborn. The Federal Reserve is expected to pursue cautious policy normalization, with gradual rate cuts likely through mid-2025. While the removal of election uncertainty is positive, the incoming Trump administration’s fiscal and trade policies introduce new variables.
Tariffs, tax reforms, and reduced immigration could create inflationary pressures and impact labor markets and growth. Despite these uncertainties, attractive yields, resilient fundamentals, and a bumpy but improving inflation environment support a sanguine outlook for fixed income and risk assets.
Global outlook
Global markets are undergoing notable shifts, driven by diverging monetary policies, geopolitical developments, and evolving fiscal priorities. In the U.S., significant policy-driven uncertainty has led to downward revisions in growth expectations. Conversely, Europe is poised for stronger growth, fueled by increased defense and infrastructure spending.
Germany’s €500 billion defense and infrastructure package and the EU’s proposed €800 billion defense plan could add 0.9%–1.5% to annual growth, pulling Europe out of its prolonged low-growth trajectory.
Emerging markets present selective opportunities, with strong fundamentals balancing the risks of trade disruption and currency volatility. While U.S. policy shifts may introduce near-term volatility, Europe’s fiscal expansion and structural re-industrialization efforts could create a more balanced global growth outlook.
For fixed income investors, these shifts underscore the importance of identifying relative value opportunities and monitoring evolving global policy trajectories to capitalize on sector-specific strengths and emerging trends.
Markets are grappling with the competing forces of inflation resilience and growth risk, as the Fed balances its dual mandate. Tariff actions have introduced a stagflationary tilt to the outlook, prompting steepening in the U.S. yield curve and renewed focus on policy signaling. Global central banks are also diverging in response to fragmented economic conditions and fiscal policy shifts.
Selective Opportunities Across Asset Classes
Though economic data has been resilient, key market indicators continue to signal an impending recession, and we strongly believe there is further economic slowing on the horizon.
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U.S. Zillow Rent Index, all homes, MoM
U.S. CPI Urban Consumers Owner Equivalent Rent of Residenes, SA
-0.50
0.00
0.50
1.00
1.50
2.00
Zillow rent index (MoM)
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
CPI owners equivalent rent (3m annual %)
2019
2020
2021
2022
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Fixed income perspectives, 2Q 2025
Private Credit enters 2025 with optimism, supported by improving macroeconomic conditions and strong middle market lending dynamics. Deal flow is recovering after years of subdued activity, driven by Federal Reserve easing, improved economic visibility, and a business-friendly policy environment.
Borrowers have navigated rate shocks through operational efficiencies, while disciplined credit structures and tight underwriting practices have kept default rates below historical averages.
Middle market direct lending offers compelling value, with yield premiums, diversification benefits, and opportunities for capital deployment attracting investors. Robust fundamentals and favorable market conditions position Private Credit to outperform in 2025, delivering strong yields and portfolio diversification. As the asset class evolves, democratization through accessible fund structures will broaden its appeal, ensuring its continued relevance in a dynamic investment landscape.
Emerging Market Debt offers selective opportunities in 2025, with projected growth near 4% and inflation largely contained. However, potential challenges include U.S. trade policies, tariff pressures, and geopolitical risks, such as ongoing conflicts and energy market volatility.
Certain EM economies, particularly China and Mexico, may face pressure from U.S. protectionist policies, while other regions stand to benefit from lower oil prices and resilient domestic demand.
EM corporates enter the year with solid fundamentals, stronger credit metrics than developed market counterparts, and yields near 6.5%. Active management will be essential, as tight spreads require careful country and sector selection. Despite these challenges, Emerging Market Debt remains a valuable allocation for fixed income portfolios, offering diversification, attractive carry, and potential outperformance through a combination of top-down macro positioning and bottom-up credit analysis.
Municipals offer a compelling combination of high yields, strong credit quality, and diversification benefits as we enter 2025.
Decade-high municipal yields enhance the relative appeal of the asset class compared to taxable fixed income, especially given the tax-exempt status, which we believe will remain intact despite political scrutiny. Credit quality across municipals is expected to remain excellent, with more upgrades than downgrades anticipated, and revenue-backed debt likely outperforming general obligation bonds.
Issuance in 2025 is projected to reach record levels, driven by infrastructure needs and delayed projects, with transportation and public utilities leading the way. Demand remains robust, bolstered by growth in ETFs, mutual funds, and separate accounts, which are expected to absorb the increased supply. Municipals’ capital preservation and attractive risk-adjusted returns position the asset class as a core holding in fixed income portfolios, with opportunities for strong performance despite potential market volatility.
Securitized Debt is poised to benefit from easing monetary policy, resilient consumer fundamentals, and strong demand for risk assets in 2025.
Declining interest rates are expected to moderate delinquencies in asset-backed securities (ABS) and support modest growth in home sales, while RMBS performance should remain stable as homeowners continue to enjoy locked-in mortgage rates well below prevailing levels. Pro-business deregulation and lower rates should ease debt burdens for corporate and commercial borrowers, driving green shoots in the CMBS market despite maturity risks and rising delinquencies in office properties.
New issuance across structured credit markets is expected to remain robust, with strong demand from banks and a risk-on sentiment supporting valuations. Despite significant spread tightening in 2024, structured credit remains attractive relative to corporate bonds, offering compelling absolute yields. Opportunities in AAA-rated CLOs and SASB CMBS provide flexibility and attractive spreads, making Securitized Debt a valuable allocation for income and risk-adjusted returns.
High yield spreads have widened more than anticipated, presenting a more favorable entry point for investors. While policy uncertainty and a shifting trade landscape have introduced volatility, fundamentals remain broadly supportive. Issuers continue to benefit from solid balance sheets, manageable maturities, and healthy interest coverage. Yields are now approaching 9% at time of writing—levels that have historically signaled strong income potential and long-term opportunity.
In the near term, market volatility may persist as companies revise guidance and issuance activity moderates amid macro uncertainty. Initial forecasts for M&A- and LBO-driven issuance are being revised lower as management teams delay capital deployment. As dispersion increases across the market, selective positioning is key. We remain focused on higher-quality issuers with strong cash flow profiles and liquidity buffers.
For investors with longer time horizons, high yield offers compelling return potential—particularly in a dislocated environment that rewards active credit selection.
Investment grade (IG) credit continues to offer relative stability and increasingly attractive valuations amid elevated macro uncertainty. Yields remain well above historical averages, supported by sound corporate fundamentals and improving relative value. While recent volatility has applied pressure to spreads, disciplined issuance trends and resilient balance sheets provide a strong foundation. Net supply is expected to decline as maturities roll off, reinforcing technical support.
With the Federal Reserve navigating a complex policy landscape, and market volatility driving dispersion, IG credit presents a compelling source of high-quality income. Looking ahead, active management and careful issuer selection will be essential for navigating an environment shaped by shifting rate expectations, global trade policy, and evolving investor sentiment.
Private credit
Emerging market debt
Municipals
Securitized debt
High yield credit
01
While economic challenges remain, we see opportunities in fixed income.
Investment implications
Credit quality of the investment grade bond index
Source: J.P. Morgan, Bloomberg, Principal Fixed Income. Data as of April 30, 2024.
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Featured insights
Q3 2023
Investment grade, high yield, and municipal sectors remain supported by strong balance sheets, healthy coverage ratios, and manageable maturity profiles. However, headline risk and trade sensitivity are creating wider dispersion—making issuer selection and credit discipline increasingly important.
Spread widening and rising all-in yields are enhancing forward return potential across credit sectors. While traditional safe havens like Treasurys and agency MBS face pressure, emerging markets, securitized assets, and private credit present attractive risk-adjusted opportunities for long-term investors. Active management is critical to navigate volatility and uncover value.
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High yield credit
High
yield credit
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Emerging
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Private
credit
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BBB Total
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Structured credit
Structured credit faces near-term headwinds from ongoing policy uncertainty—particularly around tariffs and the implementation of DOGE—which has tempered sentiment and increased market volatility. While consumer and corporate fundamentals remain broadly resilient, signs of softening are emerging as labor markets cool and delinquencies in areas like credit cards and student loans trend higher.
Commercial real estate fundamentals continue to face refinancing challenges and rising delinquencies, despite earlier signs of improving transaction activity. New issuance supply was elevated in the first quarter but may slow going forward as market volatility tests liquidity.
Spreads have widened after a prolonged tightening trend, and technical factors may continue to pressure structured markets. However, strong demand for income and the potential for Fed rate cuts later this year could provide support. Selective opportunities remain in high-quality, structurally sound segments—particularly in AAA ABS and CMBS—where recent dislocations offer a chance to capitalize on technically driven widening.
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Municipals
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Emerging market debt
Emerging market (EM) debt delivered steadier-than-expected performance in the first quarter, but recent policy developments have reignited volatility. The sharp turn in U.S. trade policy—particularly the breadth of new tariffs—has challenged growth expectations and added pressure to EM central banks. Still, EM sovereigns and corporates entered 2025 with stronger fundamentals than their developed market counterparts, supported by limited supply and solid credit metrics.
Latin American economies have been relatively insulated from direct tariff impacts, while commodity-linked issuers are adjusting to softer oil prices. Net oil importers in Asia stand to benefit from reduced input costs. Although recent spread widening has reset valuations, the opportunity set is expected to be increasingly idiosyncratic. The EM USD Aggregate Index now yields above 6.8%, offering attractive carry in a low-supply environment.
As global markets digest shifting trade dynamics, investor focus should remain on selective country exposure, carry optimization, and sovereign risk assessment.
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Private credit
Private credit continues to demonstrate resilience amid evolving market conditions, with middle market direct lending offering compelling relative value. Deal flow has recovered to more typical levels following a slowdown in 2023 and early 2024, supported by improving M&A and LBO activity. While tariff-related uncertainty and supply chain disruption may temper near-term volumes, capital availability remains robust. Elevated dry powder across private equity and credit funds is driving continued engagement in the market.
Lower interest rates have improved company valuations, incentivizing sellers and contributing to favorable credit dynamics. Default rates remain below historical norms, and recent vintages—structured under tighter underwriting standards—are expected to perform well. Investor demand continues to grow, fueled by yield premiums, structural protections, and diversification benefits.
As public markets navigate heightened volatility, private credit offers a more stable source of income and portfolio ballast. Selectivity remains key, but the asset class continues to offer long-term potential in today’s shifting landscape.
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Emerging market debt
U.S. outlook
The U.S. macroeconomic environment remains constructive but increasingly complex for fixed income investors. Inflation continues to moderate, with goods inflation near pre-COVID levels and shelter inflation showing improvement. However, uncertainty persists as significant tariff implementations under the Trump administration could reintroduce inflationary pressures, with estimates suggesting a 1.5%–2.0% increase in core PCE YoY. While the labor market remains resilient and consumer spending supports growth, fiscal tightening and slowing momentum are tempering expectations.
Policy volatility has contributed to market uncertainty, reinforcing the importance of staying focused on key macro indicators. The Federal Reserve’s gradual rate-cutting cycle is navigating these crosscurrents, balancing inflation risks with the need to support a softening economy. Moving forward, fixed income investors will need to closely monitor inflation trends, labor market developments, and the evolving impacts of fiscal and trade policies to position portfolios effectively in this dynamic landscape.
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Data as of September 30 2024. Source: Bloomberg, Principal Fixed Income. 1Total returns for representative indices. 2Spread to Treasury. Min, max, and average based on last 10 years. 3Index yield to worst. Min, max, and average based on last 10 years. Weighted average yield-to-maturity reflected for U.S. Bank Loans. Indices are unmanaged and do not take into account fees, expenses, and transaction costs, and it is not possible to invest in an index.
Indices used in order of appearance: Bloomberg U.S. Aggregate Index, S&P/LSTA (Loan Syndications and Trading Association) Leveraged Loan 100 Index, Bloomberg U.S. Corp HY 2% Issuer Capped Index, J.P. Morgan EMBI Global Diversified Index, Bloomberg Asset-Backed Securities Index, Bloomberg CMBS ERISA-Eligible Index, Bloomberg U.S. Municipal Bond Index, Bloomberg U.S. Credit Index, Bloomberg U.S. Treasury Index, Bloomberg U.S. MBS Index
Investment grade credit
02
03
04
05
06
Investment
grade credit
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90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
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Principal Fixed Income
Fixed income perspectives
Themes, outlook, and investment implications across
global fixed income markets
2Q 2025
Featured insights
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Municipal bonds continue to offer attractive relative value as volatility weighs on equity markets. Supply has surged, with nearly $125 billion issued year-to-date, placing 2025 on track for record issuance. This technical imbalance has pressured valuations, keeping municipal yields elevated and pushing municipal-to-Treasury ratios to their most attractive levels since 2022.
The 10-year ratio stands at 88%, while the 30-year ratio exceeds 95%, providing compelling entry points for crossover investors. Extending maturities within the municipal curve offers a notable risk/reward advantage, particularly for taxable investors seeking to immunize long-dated liabilities.
For traditional tax-exempt investors, elevated yields provide attractive income on both an absolute and tax-equivalent basis, with 10-year AAA municipals yielding 3.06%, translating to nearly 4.75% at the highest federal tax rate. The low correlation between municipals and equities further enhances their appeal, offering portfolio diversification and stability amid heightened volatility.
Year-to-date performance, spread, and yield for various fixed income indices
J.P. Morgan U.S. Liquid Investment Grade Corporate Index, 2015–present
>=AA-
A+
A
A-
BBB+
BBB
BBB-
11%
12%
12%
11%
12%
13%
13%
12%
11%
10%
15%
16%
16%
20%
21%
19%
20%
20%
20%
19%
19%
18%
19%
19%
17%
18%
18%
17%
16%
17%
17%
19%
19%
16%
16%
16%
16%
16%
17%
18%
17%
12%
14%
14%
17%
18%
18%
14%
15%
14%
11%
9%
9%
8%
8%
6%
7%
12%
13%
13%
11%
14%
11%
11%
10%
9%
9%
9%
9%
9%
46%
51%
44%
Performance (YTD, %)
1
Spread (bps)
2
Yield to Worst (%)
3
U.S. Aggregate
U.S. Bank Loans
U.S. HY Credit
Emerging Market Debt
U.S. ABS
U.S. CMBS
U.S. Municipals
U.S. IG Credit
U.S. Treasury
U.S. MBS
MIN
AVG
MAX
1.25
8.70
8.19
6.58
5.02
4.68
2.13
1.20
3.84
2.30
211
263
54
80
22
7
-156
720
1100
260
373
325
132
250
93
89
64
42
-90
321
418
92
122
55
36
-11
1.0
3.5
3.5
1.3
3.6
1.7
0.4
0.9
0.4
0.9
2.8
5.5
6.5
3.1
6.1
3.6
2.4
3.0
2.2
2.4
7.0
4.6
8.9
4.7
4.4
4.5
3.3
MIN
AVG
MAX
5.7
8.7
11.7
6.5
13.1
6.4
6.0
6.0
5.1
4.5
3.8
6.3
4.2
-5%
-3%
-1%
-0%
1%
3%
5%
U.S. Bank Loans
U.S. HY Credit
Emerg. Market Debt
U.S. ABS
U.S. CMBS
U.S. IG Credit
U.S. MBS
U.S. Municipals
U.S. Treasury
220
Click key to isolate
Source: Bloomberg, Principal Fixed Income. Data as of April 7, 2025. 1 Total returns for representative indices. 2 Spread to Treasury. Min, max, and average based on last 10 years. 3 Index yield to worst. Min, max, and average based on last 10 years. Weighted average yield-to-maturity reflected for U.S. Bank Loans. Indices are unmanaged and do not take into account fees, expenses, and transaction costs, and it is not possible to invest in an index.
Market environment
Year-to-date performance, spread, and yield for various fixed income indices
Performance (YTD, %)
1
Spread (bps)
2
Yield to Worst (%)
3
U.S. Aggregate
U.S. Treasury
U.S. MBS
U.S. CMBS
U.S. ABS
U.S. IG Credit
Emerg. Market Debt
U.S. Bank Loans
U.S. Municipals
U.S. HY Credit
2.52
3.08
2.87
2.54
1.66
1.13
0.54
-1.59
-1.63
-1.68
-5%
-3%
-1
1%
3%
5%
7
54
22
74
205
-156
253
132
260
325
373
720
250
1100
36
92
55
120
317
-16
411
-54
41
63
116
273
MIN
AVG
MAX
1.0
0.4
0.9
1.3
0.4
1.7
3.5
3.6
0.9
3.5
5.7
5.1
6.0
6.5
6.0
6.4
8.7
13.1
4.5
11.7
2.9
2.3
3.1
3.1
2.5
3.6
5.6
6.2
2.4
4.6
4.0
5.0
4.9
4.5
5.3
6.9
8.8
4.1
8.6
MIN
AVG
MAX
= Current Value
Policy volatility drives repricing
Credit fundamentals remain resilient
Valuation resets create opportunity
98
Securitized credit new issue spreads
Three-year range, bps, April 2022 - present
Source: Bank of America Securities, Wells Fargo Securities, Bloomberg, JP Morgan, Principal Fixed Income. Data as of April 11, 2025.
ABS Subprime Auto
ABS Equipment
ABS Consumer Loan
RMBS 2.0 CC PT
RMBS NQM AAA
CLO BSL AAA
CLO BSL BBB
CMBS Conduit AAA
CMBS Conduit BBB
CMBS SASB AAA
CMBS SASB BBB
Current
Mean
Looking ahead to 2Q 2025:
6.6
Historical U.S. high yields spreads, Fed Funds rates and recessionary periods
63
43
70
129
110
113
248
70
265
117
198
180
145
245
231
260
232
625
179
828
225
390
105
102
80
88
135
135
199
176
170
162
139
166
342
417
110
121
505
564
168
168
390
298
Monetary policy and market volatility
The Federal Reserve’s measured approach to rate cuts continues to shape market sentiment, while global central banks are responding to uneven economic conditions with varying policy paths. Uncertainty surrounding inflation persistence and trade policy impacts remains a key driver of volatility.
-54
449