Beyond mixed signals: A focus on income

So far, 2025 has been a curious year in financial markets. While U.S. equities have reached all-time highs, the economy continues to send mixed signals: Q2 GDP rebounded to a healthy 3.3%¹, but the path of inflation is still uncertain and the labor market has shown increasing signs of weakness. Meanwhile, the long-term economic impact of tariffs, the One Big Beautiful Bill Act and increased U.S. immigration enforcement remains to be seen. Still, amid this noise, income-oriented sectors of the fixed income market have produced high starting yields that can help investors achieve their long-term income objectives – and potentially with lower risk than owning stocks.

¹ Source: The Bureau of Economic Analysis. As of 7/31/25.

U.S. and emerging markets fundamentals remain solid
 

Broadly speaking, U.S. corporate fundamentals are still strong, with earnings for companies within the S&P 500 Index increasing year-over-year since the end of 2022. In addition, consensus estimates indicate that earnings will continue to grow through 2025. 

Although earnings growth may be slowing, corporate balance sheets remain in good shape, with generally low levels of debt and reasonable amortization schedules. Over the past several years, these healthy fundamentals have translated into higher average levels of quality and fewer defaults within the U.S. investment-grade corporate, high-yield and securitized credit sectors. Outside the U.S., economic fundamentals among most emerging markets (EMs) are still strong as well, as EM growth rates continue to exceed their developed markets counterparts. 

At the same time, over the past few years the U.S. dollar has generally declined against many EM local currencies, thereby helping local-currency-denominated EM bonds to appreciate in value.
 

Spreads are tight, but starting yields are high
 

Taken together, these U.S. and EM fundamentals provide a strong foundation for continued high income among many non-Treasury sectors of the fixed income market. Still, the news isn’t all sunshine: With the risk-on sentiment that 2025 has generated so far, spreads across many of these sectors have approached or exceeded their tightest levels in the past decade. As a result, these spreads have led some fixed income investors to be concerned that many non-Treasury sectors have become expensive.
 

While these concerns are understandable, a closer look at high yield, investment-grade corporates, EM and securitized credit reveals that starting yields in these sectors are still above their 10-year averages, indicating that income levels within these sectors remain very attractive. 

Given the average duration of these sectors, we believe these high starting yields may persist for some time, despite the fact that the Fed may continue to lower the federal funds target rate in 2025. Fortunately, these high starting yields also provide a cushion against negative total returns should spreads eventually widen to more historically average levels.
 

In addition, investors who’ve typically generated most of their portfolio income through dividend-paying stocks may be surprised to learn that the yield to worst on the U.S. investment-grade (IG) (BBB/Baa and above) and high-yield (BB/Ba and below) sectors currently exceeds the S&P 500 Index earnings yield, indicating that income-oriented investors are not earning a risk premium for owning equities. 

Looked at another way, income from the U.S. investment-grade and high-yield sectors can potentially exceed the S&P 500 Index earnings yield with lower risk, thereby offering investors the opportunity to generate meaningful portfolio income without the higher volatility that’s typically associated with owning stocks.
 

Active management and security selection remain key
 

Within this environment, we believe that active management and diligent security selection remain key parts of a successful long-term investment strategy. Broadly speaking, our investment-grade, high-yield and securitized credit portfolio managers have maintained an up-in-quality bias while focusing on high-conviction idiosyncratic opportunities within their respective sectors. Meanwhile, our EM debt team has reduced portfolio risk amid tighter valuations and a more ambiguous outlook for global growth. 

Investment grade: new issuance and strong yields bolster the technical backdrop

In our view, the technical backdrop for U.S. IG corporates underscores the market’s strong demand for the sector. According to figures from J.P. Morgan, gross new issuance during the first half of 2025 was $910 billion, the second-highest level for the first half of the year in history. Net new issuance, which accounts for maturities and coupon payments, was $317 billion. While market projections suggest that gross and net new issuance may be more modest in the second half of the year, this may create a supply/demand imbalance that could support spread levels going forward.
 

Year-to-date, U.S. IG corporate yields have fluctuated roughly between 4.5% and 5.5%, while U.S. equity price-to-earnings ratios have traded near all-time highs. Against this backdrop, we think potentially earning a 5.0% yield in U.S. IG corporates is an attractive proposition – especially as compared to the earnings yield on the constituents of the S&P 500 Index, which (as noted) was lower as of August 1, 2025. 

Generally speaking, we’re finding value in the pharmaceutical industry, where a number of companies have issued debt in conjunction with acquisitions and are now in the process of using free cash flow to reduce those debt levels. We’re also finding value in select companies in insurance, tobacco and utilities.
 

High yield: fundamentals and technicals support valuations
 

Since 2020, as the high-yield universe has moved up in credit quality, the sector’s fundamentals have remained solid, with both leverage and coverage ratios still below their long-term averages. That said, earnings for companies within the S&P 500 Index may slow as tariffs and interest rates weigh on consumer spending and corporate actions such as mergers and acquisitions (M&A) or capital structure changes. Despite a modest pickup in issuance, technicals are still supportive as M&A activity has been relatively muted and refinancing needs remain low. In terms of credit quality, earnings before interest, taxes, depreciation and amortization (EBITDA) margins have been relatively consistent for the past five quarters for which data are available, reflecting the broad fundamental stability of the high-yield sector. 

We continue to balance higher quality high-yield corporates with idiosyncratic ideas from across the sector. While we remain underweight consumer cyclicals, we’ve recently found opportunities in the automotive sector, where we believe select issuers were trading wide of fair value. Additionally, some of our portfolio managers have added to select liquified natural gas (LNG) operators over the past several months. We believe that demand from reshoring and the early stages of data center buildout may keep LNG demand high, and that demand may continue to increase despite the potential for slower global economic growth.
 

Emerging markets bonds: attractive yields and potential price appreciation
 

Broadly speaking, emerging markets (EM) bonds offer investors higher nominal and real yields compared to developed markets, along with the potential for further price appreciation if central banks ease policy rates. EM fundamentals have proven resilient despite recent volatility and policy uncertainty. External balances outside of select frontier markets are robust, and inflation has moderated due to restrictive monetary policies. While fiscal indicators generally remain soft, many EMs have extended the maturity of their debts or are issuing more bonds in local currency markets. At the same time, many countries have room to ease policy rates to support growth and help offset the headwinds from higher U.S. tariffs. 

We find local currency bonds appealing due to their attractive real yields relative to developed markets and the potential for price gains should central banks lower interest rates. Local currencies could also benefit relative to the U.S. dollar should higher growth differentials persist. Valuations in hard currency bond markets remain mixed, but we are identifying valuable opportunities in higher-yielding sovereign credits. Additionally, falling U.S. interest rates and continued IMF support could further enhance fundamentals.
 

Securitized credit: attractive risk-reward opportunities
 

In our view, the securitized credit market continues to offer high-quality income potential for investors at attractive spread levels compared to other fixed income sectors. We find agency mortgage-backed securities (MBS) particularly appealing based on relative valuations and the sector’s high degree of liquidity. Active coupon selection remains important, however, as the range of risk-reward profiles in the sector is currently wide, with coupons ranging from 1.0% to almost 8.0%. We favor higher-coupon mortgages, which generally have lower interest rate sensitivity and higher nominal yields compared to lower-coupon mortgages. Overall, we believe this segment of the agency MBS market offers compelling income and liquidity relative to other areas of the fixed income market, and historically, it has been more resilient during market downturns.