Sector Views: The Select Search for Income

Outlooks for fixed income sectors are based on our analysis of macroeconomic themes and the technical conditions, fundamentals and valuations for each asset class. We rate each sector from bearish to bullish to express our projections for relative returns over the next 6-12 months. The Fixed Income Outlook Dashboard reflects a high-level sector overview, with specific sector insights provided in the Sector Settings Overview. Download the PDF to read our outlook.

Our Franklin Templeton Fixed Income investment professionals share their market insights.

Mike Salm, Director of Multi-Sector and Securitized

Investors can earn meaningful income in today’s environment, but they should be wary of reaching for risk the market is not paying them to take. Instead, we believe fixed income investors should focus on resilient borrowers, short- to intermediate-maturities, and carefully selected securities. With spreads generally tight across credit markets, we do not see a broad opportunity to rely on further spread compression. Instead, we favor areas that offer strong carry with less spread-duration and downside risk, particularly in short- to intermediate-maturity investment-grade credit and securitized products. Agency mortgages will also look appealing if rates settle into a more stable range, particularly in higher coupons that provide attractive carry.

We’re more cautious in the areas of the market that aren’t adequately compensating investors for taking additional risk, such as longer-duration corporates and high-yield credit. In securitized, weaker borrowers in consumer asset-backed securities are vulnerable to higher rates and persistent inflation, and refinancing pressure and idiosyncratic risks continue to pressure commercial real estate. Nonetheless, fundamental research can identify safer pools and broaden portfolio diversification without taking uncompensated risk.

Overall, the emphasis is on security selection, higher-quality income, shorter spread duration, and avoiding tail risks rather than owning broad credit beta.

Josh Lohmeier, CFA, Director of Corporate Credit

US investment-grade corporate bonds are experiencing negative total returns due to the material increase in US government bond yields. Investment-grade bond spreads remain at historically tight levels and corporate fundamentals remain strong, providing flexibility to navigate through changing market conditions. However, current spread levels offer limited cushion against further economic, market, or geopolitical surprises. This risk is particularly evident in the technology sector, where spreads have experienced significant volatility in recent months amid a sharp increase in capital spending and debt issuance to finance the artificial intelligence buildout. 

Heavy new-issue supply, high energy prices, and uncertainty over the longer-term economic and market implications of artificial intelligence are also creating increased volatility. Against this backdrop, we believe spreads are more likely to widen modestly than tighten from current levels. This balances attractive yields and supportive fundamentals against tight valuations and rising technical risks, we maintain a neutral stance on investment grade credit while highlighting reasons for concern.

Ben Barber, CFA, Director of Municipal Bonds

Generationally high tax-exempt yields and strong fundamentals create a compelling opportunity in municipal bonds. The municipal market faced technical weakness characterized by elevated supply and tax-loss selling that led to historic underperformance and attractive tax-exempt income opportunities. Investment-grade municipal bond indexes now offer taxable-equivalent yields of approximately 8%-10%, depending on an investor’s tax jurisdiction, presenting an opportunity not seen since the turn of the century.

The outlook is further underpinned by sound municipal fundamentals, as steady employment and solid capital market returns continue to support record tax collections, while state and local government rainy-day funds remain well-funded. We expect persistent investor demand and the current income characteristics of the market to support the market over the medium term, while providing diversification when valuations across other investments remain elevated.