Importantly, Jerome Powell offered a steady hand during the March Fed meeting. His focus on the long-term outlook and reassurance that the labor market remains healthy acted as a calming influence. The Fed left the Federal Funds rate unchanged at 4.50% during the first quarter. All eyes have now turned toward a potential build-up of inflationary pressures and a higher likelihood of economic deceleration. The market remains convinced that the Federal Reserve will cut rates by 75 basis points over the course of 2025. However, if inflation metrics remain firm—or even escalate—that path seems increasingly unlikely.

The yield curve bull-steepened during the quarter as the front end led the rally. The 5-year U.S. Treasury yield fell 43 basis points, from 4.38% to 3.95%. The 30-year Treasury declined by 21 basis points, closing the quarter at 4.57%. Importantly, inflation continues to trend in a range above the Fed’s target. The most recent CPI reading of 2.8% is up from a 2024 low of 2.4% in the third quarter. Core CPI has been more encouraging. This metric—which excludes food and energy prices—fell to 3.1% year-over-year, the lowest reading since 2021. Neither measure offers a clear implication for the future path of Fed policy. However, the growing uncertainty likely points to a “higher for longer” stance from the Fed.

With some storm clouds on the horizon, where does this leave us? U.S. corporates are heading into the second quarter from a position of relative strength. With few exceptions, investment-grade corporate balance sheets remain healthy. Leverage is manageable, interest coverage is strong, and earnings growth is still positive. We expect sector and issuer dispersion to rise, as policy impacts spread unevenly across the economy. For example, auto manufacturers face a very different path than large U.S. banks.

For the first time since a brief sell-off at the beginning of August, credit yield spreads widened meaningfully last quarter. Even so, we continue to see attractive relative value in many corners of the securitized products market compared to corporates. Agency mortgage-backed securities offer compelling spreads and are poised to benefit from any deregulation in the banking sector. In a time of considerable uncertainty about the path forward, we believe this government-quality asset class offers an attractive place to be positioned and adds meaningful diversification benefits to portfolios.