Opportunities Emerge As Yields Shift Into High Gear

November marked the start of several market moving events. The October labor report fell short of expectations with disruptions from two hurricanes and a labor strike complicating the data. The unemployment rate held steady at 4.1%. And while U.S. inflation has been easing, recent data showed progress has slowed as consumer spending remains intact.

The market has also been focused on the U.S. election results. With president-elect Trump set to lead a Republican-controlled Congress, the outcome suggests potential policy shifts will impact the business environment and broader economy.

Finally, in line with market expectations, the Federal Reserve cut the overnight lending rate by 25 basis points, its second cut this easing cycle. Forward guidance continues to show an additional cut is in play at the Fed's December meeting. While the committee remains patient in evaluating incoming data and will base future decisions on the economy's underlying strength, growing expectations suggest a less aggressive Fed stance over the next year due to robust economic growth.

Chart 1, 1:19– The bond market has reacted to the flurry of data and events by repricing interest rates higher. The 10-year U.S. treasury, for example, is roughly 80 basis points above its September low. The move in yields reflects uncertainty over how tax policy, regulatory reform, tariffs and immigration policies of the incoming administration could influence growth and the federal budget. This volatility has moderated expectations for Fed easing in 2025, with futures contracts now pricing in two cuts next year.

With respect to longer term rates, our forecast continues to show a higher-for-longer environment and that current levels represent fair value for investors.

Chart 2, 1:59– So, what does this mean over the near term? Despite rising rates, the extra yield, or spread, investors require to own the risk of a U.S. corporate bond versus a U.S. treasury has declined. Credit spreads for investment grade and high yield bonds are at the lowest level since 1998 and 2007, respectively. This underscores the optimism among investors over the potential for tax cuts for businesses and individuals, as well as a more favorable regulatory regime. Continued capital inflows and strong credit quality should further support bond prices in the near term.

Chart 3, 2:35– The municipal bond market has also shown resilience despite the sharp rise in rates. The relative outperformance versus U.S. treasuries and more recently U.S. corporate bonds has benefited investors during the market turbulence. The move higher in yields offers investors the opportunity to capture attractive cash flows while positioning for better total return potential.

High yield municipal bonds have been a bright spot, posting strong returns this year. This sector of the municipal bond market is offering tax adjusted yields just over 9% and is supported by low default rates and healthy credit conditions.

In summary, sustained economic growth, a more balanced Fed, and stimulative measures from the incoming administration will likely result in yields remaining higher for longer. We expect market volatility to persist, especially as the new Congress takes charge in 2025, but view this as an extended opportunity for fixed income investors.