The Capital Markets team at PNC provides an analysis of the trends, news, and activity that took place in the market in 2024 and looks ahead to what may be on the horizon for 2025.

Foreign Exchange[*]

Interest rate differentials were the dominant theme in the latter part of 2024. Globally, efforts to lower inflation have had mixed results for different countries.  There were some, such as the Bank of Canada, that did not anticipate how aggressively they would have to cut rates given lower inflation and weak growth. The European Central Bank continued to face challenges, as inflation has not quite reached the 2% target, but the Eurozone economy is sliding. The United Kingdom faced a similar scenario, with sticky inflation and a weakening economy. In the United States, the strength of the economy, coupled with declining inflation, has allowed the Federal Reserve to slowly bring down rates. The U.S. dollar has rallied sharply due to the changing rate conditions, as well as optimism that the incoming presidential administration will embrace a strong dollar policy. 

These themes from 2024 will carry over into 2025, but there is one factor that could signal potential major shifts in currencies: tariffs. The incoming presidential administration has signaled that tariffs would be a major piece of their policy initiatives.  However, it remains to be seen if tariffs will ultimately be enacted, which global trading partners would be affected, and how these countries might respond. There are other unknowns in the U.S. beyond tariffs, including the prospect of increased fiscal spending and the question of how long rates will remain higher.

It’s clear that in 2025, the primary questions are about more than just interest rates. The dollar is likely to remain strong in early 2025, but lessons from 2024 underscore the importance of flexibility.

Taxable Fixed Income—Mortgage-Backed Securities (MBS)[**]

The start of the Fed’s rate cutting cycle was at the epicenter of the MBS market in 2024. The year started with concern about sticky inflation, a very inverted yield curve, and a delay to the start of rate cuts, all of which led to an aversion to fixed rate bonds and instead, a focus on floating rate securities.

When the Fed delivered the first 50 basis point rate cut in September, the yield curve quickly normalized, reversing one of the lengthiest inversions in recorded history. This led to a much healthier MBS market, with spreads tightening, and banks returning to the MBS market after multiple years away, as yields on MBS started to look attractive versus their funding costs. Flows started to shift towards fixed rate bonds in the second half of 2024. Despite the heightened volatility through the year, MBS spreads ended 2024 only ~10 basis points tighter, which shows there is plenty of room for further tightening in 2025.

The focus for 2025 will be on how many rate cuts the Fed can deliver, the timing of the cuts, and how the new presidential administration will impact inflation and the job market. Early data points signal a strong labor market and subdued yet sticky inflation, so time will tell. PNC expects a continuation of the normalization of the rate curve and for banks to increase their purchases of MBS as their funding costs continue to improve. In PNC’s view, MBS is historically cheap and has room to tighten.

Taxable Fixed Income—Corporate Bond Market[**]

The corporate bond market performed very well despite some headwinds in 2024. Bloomberg’s US Aggregate Corporate Average OAS Index1 tightened 25 basis points on the year, testing levels not seen since the late 1990s. Attractive yields, a strong global economy, and asset managers with cash to spend have provided an optimal environment for credit spreads, despite 2024’s robust new issue volume of $1.55 trillion. New issue volume in 2024 was up around 27% versus 2023, making it the second largest volume year on record, surpassed only by 2020’s COVID-fueled supply.

Heading into 2025, technicals remain strong for credit and are likely to keep spreads anchored at historically tight levels in the near term. PNC anticipates supply in 2025 will remain flat year-over-year. Bond redemptions are expected to be just over $1 trillion and coupon payments around $400 billion, providing a supportive environment for credit spreads as asset managers, pension funds, insurance companies, and hedge funds compete against growing passive exchange-traded funds (ETF) for bonds. The demand is likely to continue to outpace supply in the first quarter, despite anticipated heavy issuance to start the year.

The environment for credit heading into 2025 is not entirely optimistic, especially considering current risk premiums. U.S. markets were generally unaffected by geopolitical events throughout 2024, but potential global conflicts pose a risk to all asset classes and could affect credit. From a fiscal standpoint, increased government deficits would likely lead to greater U.S. treasury issuance, potentially crowding out corporate issuers and allowing investors to demand a greater credit risk premium. 

Taxable Fixed Income[**]

Closing out 2024, the most common topics in the tax-exempt fixed income space were overall supply and interest rates. Municipal bonds set a record issuance level in 2024 and are likely to increase even more in 2025. Some of the increased issuance has to do with inflation, since a project now costs significantly more than it would have just four to five years ago. The Federal Reserve has started to slowly decrease the fed funds rate, and there is a general steepening of the yield curve, which is a good sign for the overall market.

Entering 2025, in PNC’s view, these same topics will remain top of mind for investors, in addition to any potential impacts resulting from the new presidential administration. Over the last few months, municipals have performed well, considering the amount of supply. Nominal yields have been fair, and we have seen money flow into the tax-exempt market through both ETF and mutual funds. The main concern moving into 2025 is the “richness” of municipals currently compared to other asset classes. 

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Source

1. https://www.bloomberg.com/markets/rates-bonds/bloomberg-fixed-income-indices

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