Selectivity Takes the Lead

Government bond yields rose across most major markets, while inflation expectations moved higher and U.S. curves steepened. Spread sectors were more mixed: U.S. credit widened modestly, European investment grade remained resilient, and securitized products absorbed higher rates with only limited deterioration in credit spreads.

The rates move was global. The U.S. 10-year Treasury yield rose 27 basis points (bps) to 4.73%, while 10-year yields increased 35bps in Germany, 29bps in the UK, 28bps in Canada, and 32bps in New Zealand. In the U.S., the selloff was accompanied by curve steepening, with the 2s10s spread widening 15bps and the 5s30s spread increasing 10bps. Inflation expectations also rose, with 10-year breakevens increasing 5bps in the U.S. and by roughly 17 to 20bps across several European markets. These moves reflected continued uncertainty around the path of monetary policy, particularly as positive growth data and lingering inflation risks limited the scope for near-term easing.

The Federal Reserve’s month-end meeting added to that uncertainty. The Committee left rates unchanged despite three votes in favor of a 25bps hike, creating a hawkish vote split but a more measured policy signal. Chairman Warsh emphasized the tightening already delivered by higher market yields and suggested the Fed was willing to preserve flexibility rather than lead expectations with a more forceful inflation message. Markets interpreted the reaction function as comparatively dovish: the yield curve steepened, September policy expectations repriced, and breakevens moved higher. The response suggested investors viewed the Fed as prepared to let financial conditions do part of the tightening work, while remaining less explicit about what would trigger direct policy action.

Foreign exchange markets partially reversed June’s U.S. dollar strength. The broad dollar index declined approximately 1.3%, while the yen, sterling, Norwegian krone, and New Zealand dollar appreciated. Emerging-market currency performance was highly differentiated, with notable strength in the Colombian peso and Korean won, while the Hungarian forint, Turkish lira, and Egyptian pound weakened.

Credit markets remained orderly despite higher government bond yields and historically tight valuations. U.S. investment grade spreads widened 4bps to 78bps OAS, with industrials modestly underperforming financials and utilities. Longer-duration yields moved above 6%, increasing the all-in income available from high-quality corporate credit, though elevated issuance and tight starting valuations contributed to greater investor selectivity. Euro investment grade proved more resilient, tightening 1bp to 79bps, with modest outperformance from industrials and utilities. The regional divergence reinforced the importance of market and sector selection rather than broad credit beta.

High yield experienced somewhat greater pressure. U.S. high yield spreads widened 9bps to 279bps, led by a 56bps move in CCC-rated debt, while BB and single-B spreads moved more modestly. Euro high yield widened only 3bps to 272bps, although single-B credits underperformed. Primary activity and AI-related financing remained important themes, but investors continued to distinguish sharply between established businesses offering attractive carry and more speculative data center or technology-related issuers.

Leveraged loans remained characterized by substantial dispersion. Software continued to trade at a significant discount to the broader market, reflecting persistent concerns around AI disruption, refinancing, and the transparency of private-market valuations. At the same time, stronger CLO demand created selective opportunities in higher-quality software issuers with mission-critical products, shorter maturities, and stronger switching costs. The broader theme remained one of improving opportunities beneath a market that still required disciplined issuer selection.

Securitized markets faced pressure primarily from the rise in rates rather than a meaningful deterioration in credit fundamentals. Agency Mortgage-Backed Security (MBS) yields increased 33bps to 5.75%, while spreads widened 9bps to approximately 116bps versus comparable Treasuries. Thirty-year mortgage rates rose to 6.73%. By contrast, spread movements across securitized credit remained modest: agency CMBS and AAA CMBS widened only 1bp, while AAA Asset-Backed Securities (ABS) tightened slightly. Stable housing fundamentals and improving commercial real estate occupancy continued to support underlying credit performance, although higher rates and heavy issuance constrained broader spread tightening.

Emerging markets (EM) were mixed as global yields rose and country-specific developments remained the primary source of differentiation. External sovereign spreads widened 10bps to 227bps, with the Middle East underperforming as regional risk premia remained elevated. EM corporate spreads widened only modestly, while local yields rose across many markets, including Hungary, Poland, South Africa, Mexico, Indonesia, and South Korea. Political developments and policy measures in markets such as Colombia and India continued to create idiosyncratic opportunities despite the less supportive global rates backdrop.

Overall, July marked a shift from the relative stability of June toward renewed pressure from higher global yields. Fixed income markets remained functional and technical demand continued to provide support, but the combination of rising rates, tight spreads, and growing dispersion reinforced the importance of carry, relative value, and active security selection.

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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.}

^{Investing in companies in anticipation of a catalyst event, such as AI adoption, carries the risk that such catalysts may not occur, may be delayed, or that the market may react differently than expected. Companies focused on AI may have limited product lines, markets or financial resources, and their management and performance may be particularly impacted by events that adversely affect AI adoption, such as rapid changes in product technology cycles, product obsolescence, government regulation, cybersecurity concerns and competition.}