Quarterly Update: Q2 2025
Compelling Income Buffers Tight Valuations
Key Points:
- Income a return driver despite elevated market volatility.
- Issuer fundamentals remain solid.
- Full valuations warrant careful security selection.
High yield (HY) bonds delivered positive total returns in the second quarter, as investors continued to seek attractive levels of income and relative value opportunities.
Despite market ebb and flow, attainable yields and cash flow provided a strong incentive for capital deployment into risk assets vs. other bond types. Geopolitical pressure remained a moderate backdrop for credit markets during the quarter, with Middle East tensions, including threats to shipping routes in the Red Sea, contributing to broader investor caution. But these events had a limited direct impact on U.S. and emerging market corporate HY spreads. Given these dynamics, our focus has remained on corporate emerging market HY rather than sovereign debt to reduce exposure to international risks and developments. From a positioning standpoint, credit investors continue to prioritize fundamental earnings strength and balance sheet wherewithal over macro-driven risks during the quarter. Within the HY municipal bond market, the yield-to-worst of the Bloomberg Municipal High Yield Index has remained steady for most of this year, with current levels at about 90% of their 5-year range. The taxable-equivalent yield (i.e., adjusts tax-exempt municipal yield for federal taxes) of HY municipal is currently about 10%1, which is compelling vs. its fixed income peers.
Chart 1: High Yield Bonds Offer Attractive Income
Source: Bloomberg, as of June 30, 2025. Past performance is no guarantee of future results.
1 taxable equivalent yield is 37% fed + 3.8% Medicare Surcharge, 40.8%.
With a policy environment in flux and global economic projections less certain, most companies that are issuing high yield bonds continue to maintain healthy balance sheets and produce stable earnings. While there have been isolated defaults, the overall distress level remains below their longer-term averages. According to Pitchbook/LCD research, the net debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratios declined to 4.2x from 4.7x over the past quarter, demonstrating profitability and cash flow support. The average ratio over the past 10 years has been approximately 5x, according to LCD. Similarly, first-time municipal bond issuer defaults are at their lowest year-to-date since 2021, per Municipal Market Advisors (MMA)2. However, uneven economic conditions and project-specific factors may lead to an uptick in some areas of the asset class. After several years of favorable growth in operational activities, many sectors of the HY municipal bond market remain reasonably positioned for potential headwinds.
A notable observation during the quarter and on the year has been credit spread trends. The extra yield that high yield bonds offer over safe-haven government securities has tightened YTD and remains below recent years’ averages. With a more fully priced HY market, investor sentiment or shifts in fundamental credit conditions could influence risk compensation and security valuations. We continue monitoring these dynamics and remain conservative in our credit research process, with a focus on security selection and diversification. The Fed will likely drive market performance into year-end. While our base case is 1–2 FOMC rate cuts, slightly below market consensus, this suggests only modest relief for fixed rate bonds and loans, with carry remaining the primary source off total returns.
Chart 2: Bloomberg US Corporate High Yield Average Option-Adjusted Spread (OAS)
Source: Bloomberg, as of June 30, 2025. Past performance is no guarantee of future results.
The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is then adjusted to take into account an embedded option.
2 Municipal Market Advisors (MMA) data as of June 30, 2025.
Important Information
The views expressed represent the opinions of City National Rochdale, LLC (CNR) which are subject to change and are not intended as a forecast or guarantee of future results. Stated information is provided for informational purposes only, and should not be perceived as personalized investment, financial, legal or tax advice or a recommendation for any security. It is derived from proprietary and non-proprietary sources which have not been independently verified for accuracy or completeness. While CNR believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations,estimates, projections, and other forward-looking statements are based on available information and management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Diversification may not protect against market risk or loss. Past performance is no guarantee of future performance.
© 2025 City National Bank. All rights reserved.
Index Definitions
S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the US It is not an exact list of the top 500 US companies by market cap because there are other criteria that the index includes.
Bloomberg Municipal Bond Index: The Bloomberg US Municipal Bond Index measures the performance of investment grade, US dollar-denominated, long-term tax-exempt bonds.
Bloomberg Municipal High Yield Bond Index: The Bloomberg Municipal High Yield Bond Index measures the performance of non-investment grade, US dollar-denominated, and non-rated, tax-exempt bonds.
Bloomberg Investment Grade Index: The Bloomberg US Investment Grade Corporate Bond Index measures the performance of investment grade, corporate, fixed-rate bonds with maturities of one year or more.
The Dow Jones Industrial Average (DJIA) tracks thirty of America’s biggest and most established companies, acting like a quick temperature check of the U.S. economy.
The MSCI USA Large Cap Index is designed to measure the performance of the large cap segments of the US market. The index covers approximately 70% of the free float-adjusted market capitalization in the US.
The Bloomberg Investment Grade Corporate Bond Spreads refer to the spreads between investment grade, fixed-rate, taxable corporate bonds.
The Russell 1000 Value Index measures the performance of the large-cap value segment of the US equity universe. It includes Russell 1000 companies with lower price-to-book ratios, lower expected and historical growth rates.
The Russell 1000 Growth Index is a stock market index that measures the performance of the large-cap growth segment of the U.S. equity universe. It includes large and mid-cap companies that exhibit growth characteristics, and it is published and maintained by FTSE Russell.
The U.S. Treasury Index is an index that reflects recent auctions of actively traded U.S. government securities and is often used as a benchmark by lenders when establishing interest rates.
The Bloomberg U.S. Treasury: Intermediate Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury.
The Bloomberg Municipal Short-Intermediate Bond Index is a measure of the US municipal tax-exempt investment grade bond market.
The Bloomberg US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non-US industrial, utility, and financial issuers.
The Bloomberg U.S. Intermediate Corporate Bond Index is a measure of the investment grade, fixed-rate, taxable corporate bond market.
The Bloomberg AA Municipal Bond Revenue Curve index is a measure of the US municipal tax-exempt investment grade bond market. It includes general obligation and revenue bonds, which can be pre-refunded years later and get reclassified as such.
The Bloomberg US Treasury Actives Curve is a curve that relates the yield on a security to its time to maturity.
The Bloomberg US Corporate AA Corporate Bond Revenue Curve represents the effective yield of the ICE BofA AA US Corporate Index, which tracks the performance of US dollar-denominated investment-grade rated corporate debt publicly issued in the US domestic market.
Bloomberg US Corporate High Yield To Worst refers to the yield to worst of the Bloomberg U.S. Corporate High Yield Bond Index.
The Bloomberg US Agg Corporate Yield To Worst is a measure of the lowest yield the Bloomberg US Aggregate Bond Index (Agg) has ever had while its effective duration is at its highest.
The Bloomberg US Agg Treasury Yield To Worst is an index that measures the yield of US Treasury bonds.
Definitions
The “core” Personal Consumption Expenditures (PCE) price index is defined as prices excluding food and energy prices. The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation.
The Producer Price Index (PPI) is a measure of the average change over time in the selling prices received by domestic producers for their output.
A leveraged loan is a type of loan that is extended to companies or individuals that already have considerable amounts of debt or poor credit history.
Yield to worse (YTW) is the lowest potential yield that an issuer can pay on a bond without defaulting.
The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is then adjusted to take into account an embedded option.
The Magnificent 7 refers to a group of major tech companies with stock growth that far outpaced the high-performing S&P 500 in recent years. Coined in 2023, the group consists of Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla.
Nasdaq is a global electronic marketplace for buying and selling securities. Its name was originally an acronym for the National Association of Securities Dealers Automated Quotations.
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