Morgan Stanley IM: Wating for Godot, Fixed Income Edition

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Developed market government bond yields were mixed: U.S. 10-year yields fell 17 basis points (bps) to 4.23%, while German Bund yields rose 10 bps amid hawkish ECB signals and increased fiscal spending. The U.S. dollar weakened 2.1% against a basket of currencies, with all G10 currencies except the yen appreciating, and Emerging Market (EM) currencies broadly outperforming.

Emerging market debt posted strong returns, buoyed by a weaker dollar, positive fund flows, and tightening spreads across both sovereign and corporate credit. Local rates outperformed global peers, and geopolitical risks had limited lasting impact on market sentiment. South Africa, Brazil, and Indonesia saw notable yield declines, while countries like Hungary and South Korea experienced modest increases.

Corporate credit rallied across the board. U.S. and European high yield outperformed investment grade, driven by strong technicals, solid corporate fundamentals, and declining Treasury yields. Euro Investment Grade (IG) led within investment grade, supported by robust demand and favorable issuance dynamics. Securitized products also performed well, with agency MBS spreads tightening by 8 bps and non-agency Residential Mortgage-Backed Securities (RMBS) and Commercial MBS (CMBS) spreads narrowing amid strong issuance and resilient credit fundamentals.

Looking ahead, markets are pricing in two to three Fed rate cuts by year-end, though inflationary risks from tariffs and fiscal expansion remain a key uncertainty. We remain constructive on duration in developed markets, favor steepening exposures in the U.S. and Europe, and continue to see value in EM debt and securitized credit, particularly agency MBS and residential mortgage-backed securities.

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^{RISK CONSIDERATIONS}

^{Diversification neither assures a profit nor guarantees against loss in a declining market.}

^{There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g., natural disasters, health crises, terrorism, conflicts, and social unrest) that affect markets, countries, companies, or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g., portfolio liquidity) of events. Accordingly, you can lose money investing in a portfolio. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Certain U.S. government securities purchased by the strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. High-yield securities (junk bonds) are lower-rated securities that may have a higher degree of credit and liquidity risk. Sovereign debt securities are subject to default risk. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market, and interest rate risks. The currency market is highly volatile. Prices in these markets are influenced by, among other things, changing supply and demand for a particular currency; trade; fiscal, money and domestic or foreign exchange control programs and policies; and changes in domestic and foreign interest rates. Investments in foreign markets entail special risks such as currency, political, economic and market risks. The risks of investing in emerging market countries are greater than the risks generally associated with foreign investments. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, and correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Due to the possibility that prepayments will alter the cash flows on collateralized mortgage obligations (CMOs), it is not possible to determine in advance their final maturity date or average life. In addition, if the collateral securing the CMOs or any third-party guarantees are insufficient to make payments, the portfolio could sustain a loss.}