Piton Podcast: Q1 2025 Fixed Income Update and Outlook

In a quarter marked by significant market shifts, fixed income has shown strong performance while equity markets faced headwinds. The recent implementation of reciprocal tariffs has accelerated trends that were already emerging throughout Q1, creating both challenges and opportunities for fixed income investors.

Brian Lockwood, Piton's Chief Investment Officer, examines the quarter's key developments, sector performance, and how macroeconomic factors are shaping the fixed income landscape as we navigate through 2025.

Q1 2025 Fixed Income Update and Outlook Video: ~11 minutes

Recorded April 4, 2025

Q1 [0:10]: Following the trends we saw in late 2024, how have different fixed income sectors (such as Treasuries, corporates, municipals, and high yield) performed in Q1 2025? Have you seen any notable shifts?

Happy Spring, everybody. There has been some big shifts within fixed income and fixed income is off to a great start in the first quarter. Full disclosure, we are doing this video on the day after the reciprocal tariffs actually came through. So we are seeing Treasury prices sharply higher, and we're seeing stock markets and risk markets sharply lower. Let's dive in on the first quarter. Almost all market sectors of fixed income seem to have a precursor to tariff day yesterday. There's been some foreshadowing in the first quarter. Treasuries were up. Treasuries were broad. Treasuries were up about 3% across the board. Interestingly enough, corporate bonds were also up with lower rates, but not as much as treasuries, because spreads started to widen. Historically, spreads are still very low. Risk premium spreads are still very low, but they did start to waiver a little bit in the first quarter. Municipal bonds, on the other hand, they kind of just treaded water, and it was basically because of March. What happened in March is there was a very big technical factor in the fact that there was a lot of supply to the market and not a lot of maturity, so not a lot of buyers to take up that supply. In addition, there was some talk from the administration about the tax exemption, which came and went. Also, state and local governments are having some issues with how the tariffs are going to affect them. Munis were basically flat for the quarter, which actually makes munis pretty attractive as an asset class right now. One other asset class - high yield, while it was up, it wasn't up as much as investment grade, so you can see the lower quality of the bonds didn't perform as well, so high yield was up just over a percent.

Fixed Income Sector Performance in Q1 2025:

• Treasuries showed strong performance, up approximately 3% across the board

  Corporate bonds were positive but underperformed

• Treasuries as spreads began widening

• Municipal bonds remained flat due to supply issues and tax policy concerns

• High yield posted modest gains of just over 1%, lagging investment grade options

Q2 [2:49]: With the Federal Reserve having cut rates multiple times since their initial move in Q4 2024, how has the yield curve evolved in Q1 2025, and what implications does this have for investors who had been utilizing cash and short-term instruments?

Interestingly enough, cash is still at a very good level. Four and a quarter (4.25%), four and a half (4.2%), when you look at cash rates. So the interesting thing is, the Fed has kind of switched from where we thought there would be a little bit more of an easing cycle into 2025 that has kind of pushed out because the Fed has been grappling with the idea of inflation, the possibility of stagflation. Then on the other side of that is the economy going to slow enough for them to continue to cut rates. They have kind of taken a wait and see approach to cutting rates. I think the market consensus still has about two rate cuts. And now, today, with tariffs and everything, recession odds are growing. I wouldn't be surprised to see more rate cuts being pushed into the consensus. In terms of cash as an asset class, it remains a good yield, quality yield. The problem with it going forward into later 2025 and 2026 is as the Fed cuts, those rates will come down, and we are already seeing fixed income outperform cash for the first time in some time.

Yield Curve Evolution & Cash Implications:

• Cash rates remain attractive at around 4.25-4.5% despite Fed cuts

• Fed has slowed its expected easing cycle due to persistent inflation concerns

• Market consensus still anticipates about two rate cuts in 2025

• Fixed income has begun outperforming cash for the first time in several quarters

Q3 [4:28]: The first quarter of 2025 has seen significant developments in inflation data and global growth indicators. Which macroeconomic factors are currently exerting the most influence on fixed income markets, and have these surprised you compared to year-end 2024 expectations?

I think this whole quarter has been a precursor to tariffs and how tariffs would affect inflation and affect the economy. Interestingly enough, during the first quarter, the economy remained pretty buoyant. Employment was fine. What we did see is some slippage in is consumer confidence and so that coming up to tariffs, that coming up to how we would see the rest of the year shape out. I think inflation is the other big part of what we will have to look forward to, whether it is tariff related - even before the tariffs that getting down to that 2% Fed preferred rate of inflation seemed to be quite sticky and sort of started going the other way, even before we saw the tariffs enacted.

Macroeconomic Factors Influencing Markets:

• Economy remained surprisingly resilient through Q1 despite looming tariff concerns

• Consumer confidence showed notable signs of weakening ahead of tariff implementation

• Inflation remained "sticky" above the Fed's 2% target even before tariff impacts

• Markets increasingly concerned about potential stagflation risks throughout the quarter

Q4 [5:40]: Following the FOMC's 50bp rate cut in December 2024, we've seen additional policy actions in Q1 2025. How have these moves differed from market expectations, and how have you adjusted your portfolio positioning in response to the Fed's current policy trajectory?

In terms of the Fed has kind of remained on hold in the first quarter and kind of taken a wait and see approach because (a) they wanted to see how tariffs would affect the markets and (b) they wanted to see the levels of inflation which is their first mandate and then obviously price stability. From our standpoint, in terms of moving portfolios, the bar was high even if the Fed is balanced, the bar is really high for them to have any sort of rate increases. We do foresee the idea that the Fed will be cutting rates at some point in the future, so gradual increase of duration risk and also a lift in credit quality within sectors.

Fed Policy Actions & Portfolio Adjustments:

• Fed maintained a cautious "wait and see" approach during Q1, pausing on further cuts

• Central bank closely monitoring inflation trends and potential tariff impacts

• Portfolio strategy shifted toward gradually increasing duration risk

• Growing emphasis on higher credit quality within fixed income allocations

Q5 [6:48]: The recent volatility in Treasury yields during Q1 2025 has caught many investors by surprise. What's driving these fluctuations, and how should investors interpret the signals from the bond market about economic growth and inflation expectations?

I think this is really interesting because the one thing that we are seen in the first quarter is a resurgence of the negative correlations between fixed income and equities. Equity markets down a little over 4% in the first quarter, and fixed income moving up in terms of performance with rates lower, 40 basis points lower in the intermediate part of the curve, 20 basis points lower from 10 years and out. You can take from that that we now have that correlation of slower economy, fed lowering rates, run for cover, treasury markets up, corporate bond markets a little bit wider, municipal is a little bit wider. So there is this safety bid in the marketplace right now.

Treasury Yield Volatility Drivers:

• Traditional negative correlation between bonds and equities has returned to markets

• Treasury yields dropped 40bps in intermediate range and 20bps in long-term

• Equities declined over 4% while fixed income showed positive returns

• Markets pricing in expectations for slower economic growth and additional Fed easing

Q6 [8:05]: Credit spreads have tightened considerably since the start of 2025. What's driving this trend, and what does it tell us about investor sentiment regarding corporate fundamentals and default risks?

I think credit default risk is still relatively low. In essence, corporate bonds did underperform treasuries in the first quarter. They were positive. Corporate bonds were up about 2.4%, whereas MBS and risk-free rates were up about 3. What that's saying is, I think again, another precursor to what's going on with tariffs, what could possibly be the effects on the economy. When you think about corporate bonds, you own a treasury bond and a sliver of the equity of that company, and in sympathy with what equity markets did in the first quarter, and obviously, what they're doing today, we're seeing corporate spreads start to widen out. When you look at our portfolios, where our government credit portfolios were once 70% corporates and 30% governments, they're probably swapped to, right now, to 70% treasuries and government bonds to 30% corporates. So we went to a very much overweight position a few years ago to an underweight position in corporate bonds, and that's partly because the historical spread has been so tight. It's a little bit looser after the first quarter of this year but still relatively tight in terms of risk premium spreads.

Credit Spread Trends:

• Corporate bonds underperformed Treasuries despite positive returns (+2.4% vs +3%)

• Widening spreads reflected growing concerns about tariff impacts on corporate earnings

• Portfolio allocations shifted from 70% corporate/30% government to 70% government/30% corporate

• Default risk remains relatively low but investor caution is increasing

Q7 [9:44]: What advice would you give to fixed income investors who need to recalibrate their strategies based on Q1 2025 developments, particularly regarding duration management, credit exposure, and sector allocation?

I think it's a great time for active managers. I think it's also a great time for advisors and asset allocators to look at the level of bonds they've had. The truth is, the bond market has not had a good decade so far, but we're now starting to see a resurgence in the correlations we talked about earlier, but also the fact that there are a lot of uncertainties, both globally, geopolitical, inflation, economy and with tariffs here at home with the fiscal policy. That being said, I think it's important for people to know what they own in fixed income. What their true allocation is? Are they credit heavy? Are they Treasury heavy? What is the level of risk assets, even within their fixed income portfolios? Take it for higher beta sectors like EM and high yield, those act a little more like equities than they do the Treasury market. So it's important for people to know where their risk lies.

Advice for Fixed Income Investors:

• Current environment offers advantages for active management strategies

• Evaluate true allocations and understand risk exposure within fixed income holdings

• Recognize that high-beta sectors like EM and high yield behave more like equities

• Reassess fixed income allocations as traditional correlations with equities have returned

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Notes:

Attached is the support for data at the date of recording.