August 2025 review and outlook
Market environment
US corporate spreads widened by 3bp to 79bp option adjusted spread (OAS), delivering total returns of 1.01% and excess returns of -0.08%. The index yield declined 16bp to 4.91%, driven by lower Treasury rates. Top-performing sectors included oil field services, health insurance, and refining, while lodging, wirelines, and food and beverage lagged. “A” and “BBB” rated bonds both widened by 8bp. Credit curves flattened, with intermediate spreads 4bp wider and longer-dated spreads unchanged.
European spreads widened by 6bp to 85bp OAS, generating total returns of 0.02% and excess returns of -0.19%. Leading sectors were REITs, other financials, and life insurance; while wirelines, food and beverage, and technology underperformed.
High yield spreads tightened 6bp to 272bp OAS, with total returns of 1.25% and excess returns of 0.20%. Lower-quality “CCC” rated bonds continued to outperform, returning 1.86% versus 1.27% for higher-quality “BBs”. The HY index yield decreased 33bp to 6.75%. Fallen angels totaled $325m, with $2bn in defaults, and no rising stars.
The labor market weakened notably in August. Although job growth in the non-farm payrolls report was positive overall at 74,000, the number of new jobs was less than the market had expected and there were extensive downward revisions to the previous two months’ data, while government jobs declined. Additionally, the participation rate slipped back to 62.2%, its lowest level since November 2022. The forward-looking landscape also deteriorated as the Manufacturing Purchasing Managers Indicator (PMI) from the Institute of Supply Management (ISM) also dipped by more than had been anticipated, reaching 48.0, its lowest level since October 2024. Headline CPI inflation was unchanged at 2.7% but the core rate increased back above 3% for the first time since February. GDP growth provided some positive news as the preliminary estimate for the second quarter showed 3.3% expansion at an annualized rate. However, the University of Michigan Consumer Sentiment indicator dipped after two positive months. There was no policy setting meeting of the Federal Reserve, so interest rates remained unchanged, but at the Jackson Hole Economic Policy Symposium the Fed Chair provided some indication that policymakers may cut rates when they meet in mid-September.
Outlook
US economic growth may improve slightly in 2026, but we believe it will remain below trend. The labor market appears to be slowing gradually, while the PMIs remain neutral. Inflation pressure is evident in recent data and the implementation of tariffs may prevent a rapid reversal, but we do not anticipate a further surge higher. However, progress towards target inflation is likely to be slow in the foreseeable future. Despite that, we and the market expect the Fed to resume its easing cycle soon and continue to gradually cut rates toward a neutral rate over the next year. Nonetheless, the President’s ongoing attacks on the Fed leadership and its policymakers reflect a challenge to the independence of the US central bank that could undermine the market’s faith in the monetary policy. Combining that with the fiscal effects of the Big Beautiful Bill, raises the prospect of a rising term premium for holding US Treasuries ahead. With the Fed Chair’s position likely to be filled by somebody more aligned with the President’s desire for lower interest rates next year, we believe that the Treasury curve could continue to steepen further, despite the degree to which it has already. That suggests there may be less strategic value in US Treasuries ahead.
Technicals
August investment grade corporate issuance totaled $93.2bn, exceeding expectations, partly driven by favorable market conditions for issuers due to lower Treasury rates and new multiyear spread tights of 73bp on the investment grade index mid-month. Merger and acquisition funding increased to $9bn during the month, with a growing pipeline of upcoming issuers. High yield issuance remained elevated at $31.4bn. The Treasury yield curve steepened, with 5-year yields declining 27bp to 3.70%, 10-year yields down 14bp to 4.23%, and 30-year yields up 3bp to 4.93%.
Fundamentals
Credit fundamentals remain strong despite an increase in large debt-funded M&A announcements. Earnings growth rose 10.8% last quarter, with 81.6% of companies beating analyst expectations versus 77.6% in the prior quarter. Financial leverage for investment grade issuers declined slightly, EBITDA margins are at record highs, and more companies are reinstating long-term guidance. Liquidity remains robust, supported by continued debt issuance despite April’s volatility spike.
Valuations
Investment grade spreads have fully retraced April’s tariff-driven widening (peak 119bp OAS), reaching new multiyear tights of 73bp on August 15. While spreads remain historically tight, IG yields near 5% continue to offer an attractive entry point. Stable fundamentals and strong demand from yield-seeking investors should keep spreads range-bound in the near term.
Risks
- Geopolitical tensions
- Tariff-related impacts on growth and inflation
- Rising debt-funded M&A and shareholder distributions