Key takeaways
- U.S. labor market remains resilient as inflation moderates
- Credit markets continue to benefit from attractive yields and stable fundamentals
- Emerging markets are seeing divergent outcomes from higher energy prices
Labor market strength
Recent economic data continues to point to a resilient U.S. economy.
The unemployment rate held steady at 4.3% in May, while payrolls increased by 172,000 jobs. Hiring remained strongest in leisure and hospitality, though there were also encouraging signs from more cyclical areas of the economy. Construction and manufacturing both added jobs, suggesting that activity is improving in sectors that have faced challenges over the past year.
Inflation also showed signs of moderation. Core PCE slowed to an annualized rate of 3.4% in May, helped in part by the fading impact of earlier tariff-related price increases.
However, the inflation outlook remains uncertain. Historically, higher energy prices can take time to filter through the economy, creating indirect inflation pressures that may not appear immediately in the data.
Against this backdrop, markets have shifted away from expecting rate cuts and are increasingly pricing the possibility of further tightening. Our base case remains that the Federal Reserve is likely to stay on hold for an extended period as policymakers assess the balance between inflation and growth risks.
One notable development has been the flattening of the Treasury yield curve. The spread between two-year and ten-year Treasury yields has narrowed from roughly 70 basis points at the start of the year to around 40 basis points today, driven primarily by higher short-term yields.
Credit markets remain well supported
Credit fundamentals continue to provide support for fixed income markets.
Investment grade and high yield spreads remain close to recent lows, while all-in yields remain attractive. Investment grade yields are currently near 5.5%, while high yield yields are around 7.2%. These elevated yield levels continue to attract demand from both institutional and retail investors, particularly given relatively low default rates and modest corporate leverage.
The ongoing wave of large IPOs has also become an area of interest for credit investors. Following the SpaceX listing and reports of OpenAI's confidential filing, markets are increasingly focused on how these companies may eventually affect benchmark composition and index concentration.
One area we continue to monitor closely is the impact of artificial intelligence on software business models. While risks currently appear concentrated among lower-quality software issuers, the potential for broader spillovers into public credit markets remains an important watch point.
Within high yield markets, lower-quality credits have underperformed, while higher-quality segments have continued to attract investor demand.
Emerging markets face diverging outcomes
Higher oil prices are creating increasingly divergent outcomes across emerging markets.
Energy exporters have generally benefited from the recent rise in commodity prices, while energy-importing economies have faced greater challenges.
Beyond energy, however, the broader backdrop for many emerging markets remains constructive. Improved fiscal discipline, stronger policy frameworks and ongoing stabilization efforts have helped support economic fundamentals across several countries.
Importantly, inflation pass-through from higher energy prices has been more muted than during previous commodity shocks. Alternative inflation measures also continue to point toward moderating inflation across many emerging economies.
As a result, several emerging market central banks may have greater flexibility to normalize policy over time. We continue to see selective opportunities in emerging market debt, particularly within quasi-sovereign issuers.