CONTRIBUTORS
Michael Buchanan, CFA
Chief Investment Officer
Western Asset
The case for fixed income remains compelling. Resilient growth, moderating inflation and the AI infrastructure buildout are creating powerful, targeted opportunities, even as markets overprice policy risk. With spreads tight, discipline matters: we are leaning into high-quality AI-related issuance, BBB CMBS, single-B bank loans, CLO tranches and select frontier and EM local currency debt where fundamentals are strong and valuations pay us for risk.
Key highlights:
- Middle East tensions and energy disruption drive volatility, but inflation risks may ease if oil falls and a fragile peace holds.
- US growth is supported by AI capex, resilient consumers, strong earnings and pro-business policy, while labor stabilizes and the Fed stays inflation-focused.
- Europe’s downside risks are fading as surveys bottom, energy costs decline and German fiscal stimulus builds; the UK faces softer labor, sticky inflation and fiscal uncertainty.
- Canada’s recovery is improving, Australia is slowing under tighter policy, Japan faces higher JGB yields, and China’s export resilience contrasts with weak domestic demand.
- IG and HY fundamentals remain sound, but spreads are near tights and issuance is elevated by AI capex, M&A and refinancing; yield demand supports technicals.
- Structured credit is selective: CLO carry, non-agency MBS and CMBS offer value, while lower-credit consumer ABS remains challenged.
- EM benefits from positive fundamentals. Spreads are tight, so expect to earn carry while value can be found in frontier sovereigns, high-real-yield local markets and EM corporates.
- Sector views favor banks, select AI-linked tech/utility, energy and transportation; caution remains on autos, retail, food & beverage and lower-quality consumer credit.
Overview
Western Asset’s fixed-income outlook remains constructive but selective as resilient growth, elevated inflation, hawkish central-bank pricing and the AI infrastructure buildout intersect. Middle East tensions, energy volatility and tariff pressure create uncertainty, but the global economy has absorbed these crosscurrents, supported by the US consumer, European fiscal spending and AI capex. Inflation remains the key constraint on policy flexibility, though we expect it to moderate in 2H26 and into 2027 as tariff effects, tax-related support and energy pass-through fade; market-implied hiking paths may be somewhat overdone. Credit fundamentals remain sound across IG and HY, but tight spreads leave less room for broad beta exposure and make selectivity critical. We see opportunities in high-quality AI-related issuance, BBB CMBS, single-B bank loans, CLO tranches and select EM local currency debt or frontier markets. Sector positioning favors resilient banks, select AI-linked tech/utilities and select energy/transportation, while caution remains in consumer-facing and lower-quality credit.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
Fixed-income securities involve interest rate, credit, inflation and reinvestment risks and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
Municipal income may be subject to state and local taxes. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.
Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value.
Floating-rate loans and debt securities are typically rated below investment grade and are subject to greater risk of default, which could result in loss of principal. Inflation-linked securities are subject to liquidity risk, prepayment risk, extension risk and deflation risk.
US Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the US government. The US government guarantees the principal and interest payments on US Treasuries when the securities are held to maturity. Unlike US Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the US government. Even when the US government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.
WF: 11852258