September 2025 review and outlook
Market environment
US corporate spreads tightened by 5bp to 74bp OAS, delivering total returns of 1.50% and excess returns of 0.48%. The index yield declined 10bp to 4.81%, driven by tighter spreads and lower long-end Treasury rates. Top performers included health insurance, independent energy and oil field services, while cable and satellite and chemicals lagged. “A”- and “BBB”-rated bonds both tightened 6bp. Credit curves steepened: intermediate maturities tightened 6bp and longer-dated spreads tightened 4bp.
European investment-grade spreads tightened 6bp to 79bp option adjusted spread (OAS), generating total returns of 0.39% and excess returns of 0.38%. Leading sectors were integrated energy, food and beverage and banking; diversified manufacturing, REITs and transportation underperformed.
High-yield spreads tightened 6bp to 272bp OAS, with total returns of 0.82% and excess returns of 0.48%. Lower-quality “CCC”-rated bonds outperformed, returning 0.98% versus 0.82% for “BBs”. The high yield index yield fell 5bp to 6.70%. There were no fallen angels; defaults totaled $1.6bn, while rising stars amounted to $850m.
In the US, the Fed funds rate was cut by 25bp, as expected. While US GDP growth for Q2 was revised higher to 3.8% year-on-year, other economic data for September 2025 was less positive, adding to concerns that economic momentum may be waning. The labor market remained soft, with non-farm payrolls increasing by just 22,000, while jobs were lost in both government and manufacturing sectors. The unemployment rate edged up to 4.3%, which was in line with market expectations, but took the jobless rate to its highest level since the post-pandemic recovery was underway in 2021. The year-on-year growth rate in average hourly earnings eased to 3.7% as the 3-year long down trend remained intact. Headline inflation rose once more, as the consensus had expected, pushing the annual rate to 2.9%, while core inflation held steady at 3.1%. Business confidence showed mixed signals: the ISM Manufacturing PMI rose marginally to 48.7, still in contraction territory, but the New Orders Index moved into expansion at 51.4. However, the employment component remained weak. In contrast, the Philadelphia Fed Manufacturing Index rose substantially, to 23.2, well above market expectations. Consumer sentiment deteriorated, with the University of Michigan’s Index of Consumer Sentiment falling to 55.1 from 58.2 in August, driven by growing concerns over inflation, labor market conditions, and trade policy. At the time of this writing, the US government entered a shutdown in the wake of failure to reach congressional agreement on raising the debt ceiling.
Outlook
Some macro indicators suggest there is resilience within the US economy, but other factors such as the evidence that the labor market may be softening significantly, align more with further slowdown. While we continue to believe that a recession is unlikely, it does remain a clear risk if the effects of tariffs and immigration crackdowns squeeze demand further. We anticipate GDP growth of 1.6% for 2025, with similar sub-trend activity again in 2026. Inflation is still above the Fed’s target and the effects of tariffs are likely to maintain upward pressure on prices if businesses do not or cannot absorb them. However, the weaker labor market may further dull demand and help prevent an unruly escalation in inflation levels. We expect the inflation rate to be around 2.7% this year and 2.8% in 2026. Having eventually resumed its easing cycle after nine months, the Fed appears to be turning its attention as much to the labor market as to tariffs, and we see further cuts to come in 2025 and potentially into 2026, taking the Fed funds rate to the 3.25% to 3.5% range. Treasury yields are expected to ease, with the 10-year yield declining below 4%, towards 3.85% in 12 months’ time. The backdrop of political pressure on the Fed and expansive fiscal policy creates some further potential for bond market volatility. The US government shutdown will potentially lead to weaker sentiment and, until resolved, reduce the availability of data produced at a federal level (including the high-profile non-farm payrolls data).
Technicals
September investment-grade corporate issuance totaled $188.3bn, the fifth-largest month on record, driven by spreads near 72bp OAS and lower long-end yields. Long-end issuance rose to 15% of total (vs. an 11% YTD average). M&A-related deals reached $17bn, the most since March. High-yield issuance was elevated at $57.9bn, the third largest on record. The Treasury yield curve flattened.
Fundamentals
Credit fundamentals remain strong. Earnings grew 10.8% last quarter, with 81.6% of companies beating analyst expectations (vs. 77.6% prior). Financial leverage for investment grade issuers edged down, interest coverage improved as rates eased, and EBITDA margins sit at record highs. Liquidity remains ample, backed by robust free cash flow and ongoing debt issuance. Rising M&A activity may modestly pressure fundamentals heading into next year.
Valuations
Investment grade spreads are at multiyear tights, reaching 72bp OAS on September 18 and staying below 80 for two months. With yields near 5%, investment grade offers an attractive long-term entry point, supporting positive fund flows. However, tight valuations and weaker employment data raise the risk of spread widening into year-end.
Risks
- Weaker employment data impacting the consumer
- Geopolitical tensions
- Tariff-related impacts on growth and inflation
- Rising debt-funded M&A and shareholder distributions