First Quarter 2025 in Review

First quarter 2025 may have been the calm before the storm. Treasury rates declined across the yield curve as concerns about muted growth prospects emerged due to indications the U.S. government planned to introduce protectionist trade policies. These concerns impacted investor predictions for forward-looking Fed interest rate decisions, indicating one additional Fed rate cut was expected and bringing the tally of expectations to four cuts by year end. The next Fed decision is scheduled for May 7th, and investors predict no change to the federal funds rate at that meeting.

The Bloomberg U.S. Aggregate Index returned 2.8% during the first quarter as interest rates declined and credit spreads widened modestly from a low base. Riskier market segments underperformed high-quality bonds. The Bloomberg U.S. Corporate High Yield Index returned 1.0%, and the S&P 500 Index returned -4.3%. All major credit segments of the Bloomberg U.S. Aggregate Index had negative excess returns during the quarter.

Credit issuance remained robust during the quarter, with issuers refinancing short maturities amid low credit spreads, muted volatility, and strong demand. High-grade corporate bond issuance increased 19% while high yield issuance (bonds plus loans) was flat year over year. Asset-backed securities (ABS) issuance was flat, but nontraditional ABS volumes increased 10% from 2024’s pace. Commercial mortgage-backed securities (CMBS) volumes jumped 139% off a lower base year over year. Net issuance was modest but positive in all credit sectors.

With spreads wider and positive net issuance, opportunities are emerging in pockets of the market. The percentage of credits that screened as a “buy” increased to 11% from 4% for investment-grade corporate bonds and to 38% from 16% for high yield corporate bonds. The percentage of loans screening as a “buy” decreased though to 45% from 58%. Within the investment-grade corporate credit market, interest rate sensitive sectors like life insurance, finance companies, and banks continue to screen attractively, while opportunities are also emerging in consumer cyclical companies. Tariff pressures should have a greater effect on more leveraged businesses in the high yield market, which drove credit spreads towards more appropriate ranges.

Away from credits in mainstream indexes, spreads in some ABS subsectors increased towards their long-term averages. Most nontraditional ABS continue to screen attractively in our valuation framework and offer appealing yield prospects. Data center ABS spreads widened from very low levels as concerns over long-term data center demand arose from artificial intelligence (AI) efficiency improvements and potential tariffs. CMBS spreads in select opportunities remain disconnected from their credit profiles, as property-level dynamics remain imperative for performance.

Valuations are not yet broadly attractive, and caution is still warranted in several areas of the market. Agency mortgage-backed securities (MBS) valuations remain broadly unattractive as spreads compressed further, with no cohort of the 15- or 30-year MBS market screening as a “buy” candidate. Negative excess returns remain possible for most of the investment-grade corporate bond universe. Less than half of the high yield corporate bond and loan markets screen attractively, highlighting the importance of a selective approach. Spreads on collateralized loan obligation (CLO) debt widened from very narrow levels to below-average levels. Emerging market credits remain unappealing due to concerns over creditor rights in most countries and its impact on their durability, compounded with the uncertainties that tariffs may impose on supply chains. We believe nonagency residential mortgage-backed securities (RMBS) remain plagued by poor issuance trends, unattractive valuations, and weak fundamentals.

Valuations reflect a growing belief that the U.S. economy is slowing. GDP estimates declined and suggested a recession is possible. Changing global tariff policies have weighed on business and consumer sentiment while also driving concerns about inflation.

Credit performance of business loans have been strong, although recent tariff policies may challenge future credit performance. Defaults trended lower, while recoveries improved. U.S. business bankruptcies remain low, and business loans held at banks are performing well. There has been an increase in pay-in-kind (PIK) interest for loans held in some private credit structures. We are monitoring the increase in PIK loans closely to distinguish between unique borrower business models vs. inabilities to service debt.

U.S. consumer debt dynamics suggest a weaker, but not currently worrisome, outlook. Delinquency rates and charge-offs are rising toward normalized levels even as the pause on student loan payments remains. However, conditions for ABS structures and banks with exposure to consumer loans are manageable. This section of the market remains able to withstand losses without risk of impairment, while performance should be more resilient in ABS issuers with tight underwriting standards.

Commercial real estate credit performance paints a mixed picture. Delinquency rates are rising across sectors, but there has been a recent, notable improvement in the delinquency rate of single-asset, single-borrower (SASB) office properties. There is mounting evidence that property-level differentiation is driving better CMBS outcomes. For example, return to office dynamics may be stronger in some markets than others, consistent with our observations and multiple data sources. The market has been open for issuers seeking to refinance, and deals backed by higher quality properties are well received in the market. Weakening office market values had limited impact on banks’ commercial real estate loan portfolios to date, suggesting risks of contagion are limited. BBH has historically owned minimal SASB office exposure in portfolios given our credit selectivity and poor value.

Recent Market Developments

As we write this commentary, the first quarter feels like the distant past. On April 2, 2025, U.S. President Trump announced a sweeping round of tariffs that were larger than anticipated. In response, retaliatory tariffs were directed back at the U.S. The U.S. tariffs were intended to go into effect on April 9th, but a 90-day pause was announced for most trading partners, with a notable exception being China. The tariffs introduced significant uncertainties for businesses and capital markets. Recession and inflation concerns rose as GDP estimates declined. The University of Michigan’s Surveys of Consumers report released on April 11th revealed U.S. consumers’ year-ahead inflation forecast spiked to 6.7% – its highest reading since 1981.

The S&P 500 cratered over 10%, and “fear” indexes of implied volatility surged. U.S. Treasury rates were volatile, with long-term interest rates notably higher – a development of concern amid recession fears. Credit spreads widened further, but so far systemic concerns seem limited. High-grade corporate credit spreads widened 20 basis points (bps)¹ towards the long-term, non-recessionary average level – not stressed or distressed levels. New issuance resumed after a brief pause, and liquidity has been available in secondary markets.

This remains an evolving situation. Tariffs levels and their expected duration can change quickly. Many believe the tariffs are a tool to trigger renegotiations of trade agreements rather than a means of providing a level of protection for domestic industries. The impact that this situation will have on markets and the real economy in the long term is unclear.

Concluding Remarks

Uncertainty over tariffs is already having a recessionary impact on business activity and could pressure the performance of many industries and companies. We remain steadfast in our approach, focusing on identifying durable credits² – those that can withstand the worst environments faced by their issuer’s industries – at attractive yields. We do this by evaluating individual opportunities bottom-up and not allowing top-down sentiments to alter the application of this approach. We believe this decision-making structure serves our clients well in all environments, whether markets are calm and complacent or volatile and uncertain.