1st Quarter 2025 Fixed Income Review
- The Federal Open Market Committee (FOMC) left its fed funds target rate in a range of 4.25% to 4.50% during the first quarter
- At their March meeting, Fed officials indicated that they expected two 25 basis point cuts during 2025, which was the same as their December meeting. Marked weakness in equity markets following a significant shift in global trade policy has futures markets currently indicating the probability of up to two additional cuts in 2025
- Due to slower growth in the first quarter than in 2024, US Treasury (UST) yields declined, known as a “bull steepener,” as shorter-term yields fell more than longer-term yields indicating the Treasury market was positioning for a slowing economy
- The core rate of inflation has declined but is still higher than the Federal Reserve’s stated target of around 2%. The Federal Reserve’s preferred measure of inflation, Core PCE, stood at 2.80% at the most recent release (February)
- Recent comments from Fed Chairman Powell indicate continued concern for longer-term inflation expectations as the FOMC awaits more data to support additional policy moves
Below are select Bloomberg fixed income index returns for Q1 2025:
The Fed- Caught Between a Rock and a Hard Place
Given the uncertain near-term implications of recent changes to tariff and trade policy, as well as repercussions from the planned large-scale reduction of the federal workforce announced by the newly formed Department of Government Efficiency (DOGE), the Fed remains on hold, or as Fed Chair Powell recently put it, “well-positioned to wait for greater clarity.”
Market-based expectations of future monetary policy activity have increased in recent days following President Trump’s announcement of sweeping new tariffs on imported goods from across the world. His announcement has already sparked retaliatory responses from several key trading partners, including China and Canada, as of the time of this writing. Although the potential inflationary effects of new tariffs remain to be documented by economic data, many economists believe the new policy is highly likely to at least generate a temporary rise in inflation.
There was no change in the fed funds rate, currently at 4.25%-4.50%, at the FOMC’s most recent meeting in March. However, one significant policy announcement related to quantitative tightening (the reduction of money supply by allowing bonds in the Federal Reserve’s massive portfolio to mature while not reinvesting the proceeds) did materialize. The Fed did release guidance slowing the pace of balance sheet reduction, lowering the maximum monthly amount of Treasury securities allowed to roll off of the balance sheet from $25 billion to $5 billion. The cap for mortgage-backed securities allowed to roll off was held firm at $35 billion per month. Chairman Powell later clarified the changes were in keeping with the Fed’s long-term intention of maintaining a balance sheet comprised mostly of UST holdings.
Markets and the Yield Curve
As mentioned above, although volatile early on, UST yields declined materially during the first quarter. The 2-year UST hit a high yield of 4.38% in January before declining to 3.88% at quarter-end. Likewise, the 10-year UST posted a high yield of 4.79% in January before declining to a first-quarter low of 4.16% in early March. The 2-year to 10-year yield differential was positively sloped at 32 basis points at the end of the first quarter. The 2-year and 10-year UST rates were 3.78% and 4.20% respectively, as of the time of this writing.
For the first time in several quarters, US Corporate High Yield did not outperform higher-quality sectors of fixed income as economic uncertainty caused yield spreads to widen in the lower echelons of credit. In a dramatic turnaround from 2024, investors looked to lock in duration as longer-dated US Treasuries and Investment Grade corporate bonds turned in a very solid quarter.
In unusual form, short-term municipals underperformed USTs and Investment Grade corporate bonds during the first quarter. Amid large amounts of new bond issuance and unusually light seasonal reinvestment demand, municipal prices closed the quarter at levels — compared to counterpart UST securities — not seen in many months. We believe these factors have combined to provide an attractive time to add tax-exempt municipals to fixed income allocations, where appropriate.
What We Think
Marked weakness in foreign and domestic equity markets following the president’s recent trade policy announcements have produced predictable calls from Wall Street for immediate easing of rates to support risk assets. Yet, it is clear the US Central Bank must make sure the potentially wide-ranging economic impact of a new global trade policy does not stoke inflation. Tariffs, essentially a tax on imported goods, will likely raise prices on consumer goods and services alike, and it remains unclear who will bear the burden.
Higher inflation and slower growth? As mentioned earlier, recent announcements from the Trump administration challenge both sides of the Fed’s mandate to maintain stable prices and maximum employment. Fed Chair Jerome Powell recently indicated an ongoing concern for longer-term inflation even as equity markets were under pressure. Barring some sort of economic calamity, the Fed likely remains on hold as they wait for more data.
As running into a dark room increases one’s risk of injury- the lack of economic visibility increases risks in the fixed income markets in a similar fashion. Prospects for a slowing US and global economy have already affected fixed income markets with volatile price swings in the UST markets, and increasing “yield spreads” across the board. We are not recommending adding duration at this time. Although not at historically wide ranges, we are cautiously watching yield spreads on high-yield and other more peripheral sectors of fixed income for opportunities as uncertainty creates pricing dislocations. Likewise, as mentioned earlier, we do believe the normally very safe investment grade tax-exempt market is attractive at current levels.
We appreciate your ongoing confidence and hope you will contact either your Argent Portfolio Manager or any member of our fixed-income team (below) with questions or comments regarding fixed-income or the markets in general.
Not Investment Advice or an Offer | This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing.
Sam Boldrick, Hutch Bryan and Matthew Kimbrough all contributed to this commentary. No artificial intelligence or ChatGPT were used in the collection of information or production of this content. For additional information please contact one of the following:
Sam Boldrick: sboldrick@argenttrust.com
Hutch Bryan: hbryan@argenttrust.com
Matthew Kimbrough: mkimbrough@argenttrust.com
