Credit Markets Tough Out March Madness

March brought another month of heightened volatility for fixed-income markets driven by investor concerns over stress in the private credit sector, the potential for AI-driven labor displacement and escalating geopolitical tensions in the Middle East. Together, these crosscurrents added to uncertainty and led to a repricing of central bank policy and inflation expectations.

Chart 1, 0:35– In the U.S., we saw the U.S. Treasury curve flatten meaningfully. Two-year yields tested 4%—moving above the upper bound of the Federal Funds rate—as investors grappled with the effects of the energy price shock from the Iran war. That shift largely erased market-based expectations for rate cuts this year. Longer-term yields also moved higher, though more modestly. Ten-year yields approached 4.5% before pulling back to 4.3% by month-end, reflecting growing concerns about economic growth in an extended Middle East conflict. Overall, Treasury yields increased by 30-45 basis points across the curve in March.

At its March meeting, the Fed held rates steady at as expected. Updated projections showed upward revisions to both growth and inflation, while the labor market continues to be viewed as resilient and broadly balanced. Importantly, Chairman Powell also signaled a willingness to look past short-term energy price increases, reinforcing market expectations for an extended pause in policy. Despite the inflation risk, we have not changed our view of Fed policy this year, and we continue to expect cuts given weakness in employment. If a resolution with Iran holds, the price impact is likely to be short-lived and the market will return to its focus on AI disruption.

Chart 2, 1:58– Market volatility weighed on fixed income performance in March, pushing year-to-date returns into negative territory. The primary driver was the sharp rise in yields, alongside modest downdrafts in credit-sensitive sectors and a stronger U.S. dollar, which pressured global bonds. Despite these headwinds, corporate credit held up relatively well. While the initial escalation of geopolitical tensions triggered spread widening—with investment-grade credits edging modestly wider and high-yield bonds experiencing a more pronounced reaction—this proved short-lived.

Chart 3, 2:23–  By month-end, spreads had largely retraced to pre-conflict levels and remained tight relative to long-term averages. Overall, this dynamic reflects a normalization in risk pricing driven by higher rates and increased volatility rather than a deterioration in underlying credit fundamentals.

Chart 4, 2:52– Despite a strong start to the year, the municipal market was not immune to broader Treasury volatility. Municipals sold off across the curve, with benchmark yields rising 40-60 bps—outpacing the move in Treasuries. The 5- to 10-year part of the curve was the weakest performer, reflecting a needed repricing after a strong rally that began late last year. Importantly, this reset has improved valuations meaningfully, and taxable equivalent yields look attractive for high-quality paper where credit fundamentals remain strong. As a result, municipals appear better positioned moving forward, especially if market volatility persists.

To bring this together, fixed-income markets are currently navigating crosscurrents between inflation risks and slowing economic growth. Our base case remains that energy serves as the primary transmission mechanism for these dynamics, with the duration and magnitude of the Iran conflict being critical determinants of the global economic impact. We are encouraged by the ceasefire negotiations, but remain cautious on the war’s long-term conclusion. While geopolitical risk has created noise, we do not see indications of systemic stress and the credit market behavior reinforces this view. The recent volatility appears driven by rate sensitivity rather than fundamental credit deterioration.

Looking ahead, we anticipate the 10-year U.S. Treasury yield to range between 3.75% and 4.25%, with the Federal Reserve likely to remain on hold until the second half of 2026. However, the Fed remains data-dependent and patient, and we continue to see a plausible path toward lower rates later in the year. Despite higher yields, credit markets have demonstrated stability, creating opportunities across fixed income— especially in the municipal bond market. Our recommendation: stay on course with your investment strategy.