Piton Webinar: Q3 2025 Fixed Income Update and Outlook

Welcome to Piton Investment Management's Q3 2025 Fixed Income Update and Outlook with CIO Brian Lockwood.

The third quarter of 2025 has proven to be a pivotal period for fixed income markets as the Federal Reserve finally ended its nine-month pause and began cutting rates in September. The Fed delivered a quarter-point cut on September 17th, bringing the federal funds rate to 4.00%-4.25%, with officials signaling two additional cuts are likely before year-end. This monetary policy shift comes amid mixed economic signals, with August CPI rising 2.9% year-over-year while core inflation remains elevated at 3.1%, and unemployment edging up to 4.3% as job gains have slowed. Meanwhile, tariff impacts are gradually working through the economy, with Fed research showing trade policies have contributed approximately 0.08 percentage points to core PCE inflation so far this year. Today, Brian examines how these developments have reshaped fixed income positioning as we head into the final quarter of 2025.

Recorded October 1, 2025

Let's dive in. Our first question is:

Q1. After nine months of Fed inactivity, the central bank finally cut rates by 25 basis points in September and signaled two more cuts are coming. How have different fixed income sectors performed during Q3 2025, and which areas benefited most from this shift toward monetary easing?

In general, the fixed income markets have had a really good year and a pretty good third quarter, so to speak. The run-up into the Fed Ease was a classic “buy the rumor” and “sell the facts” kind of happening in the bond market. So we did see bond prices move up, both treasuries and corporate bonds did well in sympathy with risk markets that did well. I think we'd be talking about a really solid fixed income quarter and fixed income year had it not been for the fact that risk markets and equity markets are once again having a banner year. But in general, we saw some strong markets into the third quarter.

Q3 2025 Fixed Income Sector Performance and Fed Rate Cut Impact

• Fixed income delivered strong Q3 and full-year returns with classic "buy the rumor, sell the fact" pattern into September Fed cut.

• Treasuries and corporate bonds rallied in sympathy with strong risk markets.

• Equity markets posted banner year returns, overshadowing solid fixed income performance.

Q2. The Fed's September decision featured an 11-to-1 vote with only newly appointed Governor Stephen Miran dissenting for a larger 50 basis point cut. How has the Fed's cautious approach to rate cuts affected the yield curve in Q3, and what are the implications for duration positioning?

Good question on duration. It's interesting, fixed income markets have, in general, have done better than cash into 2025. What we've seen throughout most of the year, up until September, was a steepening of the yield curve where the front end did much better. And then intermediate bonds did much better than longer term bonds. And then after the Fed lowered rates in September, we started to see the yield curve start to shift, and we started to see a little bit of a flattening out of the yield curve, where longer term bonds started to catch up. That's an interesting approach because in a fed easing cycle, we tend to see the yield curve act like a whip, where the front end starts to go up because they anticipate the cycle of lower rates coming, and then it starts to feed out to the longer parts of the yield curve. Right now, we're favoring that five-to-seven-year part of the yield curve within our portfolios.

Yield Curve Dynamics and Duration Positioning Post-Rate Cut

• Fixed income outperformed cash throughout 2025, with yield curve steepening as front and intermediate end led performance.

• Post-September cut, curve began flattening as longer bonds caught up—typical "whip" effect in easing cycles.

• Piton currently favors the five-to-seven-year part of the curve.

Q3. Inflation data through August showed headlines at 2.9% with core at 3.1%, while Fed officials acknowledge that tariff impacts are "continuing to build" through the economy. How are you interpreting these persistent inflation pressures, and what does it mean for the Fed's projected path of two additional cuts this year?

I think it's been talked about a lot, the kind of the two-sided coin of both — (1) we have inflation to worry about mostly from the tariffs that are coming in, and (2) the Fed is doing everything in their power, not to use that word, transitory again. I think even coming up to this Fed ease, we were talking much more about the employment situation, and the Fed was talking more about the employment situation, and with good reason. We had some revisions to a string of the summer months, where we saw much lower employment growth. I think that is what we are going to start to see as the main thing that the Fed will start to focus on going forward, especially if those numbers continue to come in much lower. Don't forget, if we get much lower inflation over the course of the next 6, 9, 12 months, Inflation is going to take care of itself as people don't want to spend money because they're losing their job.

Persistent Inflation Pressures and Fed Policy Outlook

• Headline inflation at 2.9%, core at 3.1% through August, driven by ongoing tariff impacts.

• Fed shifted focus to employment after downward revisions to summer job growth data.

• Employment weakness may resolve inflation naturally through reduced consumer spending over 6-12 months.

Q4. The Fed's updated dot plot now shows the fed funds rate falling to 3.5%-3.75% by year-end 2025, implying two more quarter-point cuts. How has this more dovish outlook influenced your portfolio positioning, particularly given the ongoing uncertainty around tariff policies and their inflationary effects?

We talked about this a little bit, but cash no longer seems to be king, at least, versus fixed income markets. You are seeing people start to move out the curve, and that's moving duration out. I think whereas there are some investors or risk-averse investors that might have been in cash markets, they are moving out towards short duration markets or even towards intermediate markets, and we think that's the right play. The fact that we still have some inflation worry and some deficit worry keeps us thinking — for a risk-averse investor, why be out in the longer, very long part of the curve with aggregate portfolios. So that sweet spot right now is intermediate, zero to 10-year bonds, whether it's in taxable or tax-exempt markets. We think it's been the sweet spot for a good part of the year and we think it will be into further easings with the Fed.

Portfolio Positioning Amid Dovish Fed Outlook and Tariff Uncertainty

• Fed dot plot projects fed funds at 3.5%-3.75% by year-end, implying two more quarter-point cuts.

• Cash no longer king versus fixed income; investors moving from cash to short and intermediate duration.

• Sweet spot remains intermediate bonds (0-10 years) in both taxable and tax-exempt markets.

Q5. Corporate spreads have tightened to just 83 basis points for investment grade, while municipal bonds are offering compelling tax-equivalent yields of nearly 6% for high-quality long-term issues. Municipal fund flows have turned positive with $2.2 billion in recent inflows after a challenging first half. How are you navigating these spread dynamics and where do you see the best relative value in credit markets?

This is a really good question because this is what active managers grapple with from day to day. You probably heard credit spreads are extremely tight — they are decades tight to treasury markets. So where is the risk return? We generally are lowering our allocation to corporate bonds because spreads are so tight, and we're not seeing the great total return scenarios with some of the lower grade corporate bonds. Given that, they have had a great year. Emerging markets have had a good year — that's a little bit because of the US dollar. Corporate bonds high yield has had a really good year in sympathy with equity markets going up. But right now, they are just at a level that you are not getting enough “bang for the buck” for having a big allocation to corporate bonds, so we are looking to other areas. We are looking at mortgages, for instance, that have a good OES spread versus treasury markets right now — and some of the other taxable municipal bonds also offer some good spread. The municipal market, the intermediate sector, did have a good total return into the year. It was a long end that really dragged it down, but now we are starting to see the longer end show some real value, as you mentioned. And in 10 to 30 years, municipal bond markets out there have some really attractive tax-exempt yields that are high on their ratios compared to treasuries.

Credit Spread Dynamics and Relative Value Opportunities

• Investment-grade spreads tightened to 83 basis points — decades-tight levels reducing corporate bond appeal.

• Municipal bonds offering compelling yields with $2.2 billion in recent positive flows.

• Better value in mortgages, taxable Munis, and 10-to-30-year municipal bonds with attractive ratios to Treasuries.

Q6. Professional forecasters now project 1.7% GDP growth for 2025 with unemployment averaging 4.2%, while the Fed balances slowing growth against persistent inflation pressures. What strategic adjustments should fixed income investors be making for Q4 and into 2026, especially given the uncertain trajectory of both monetary policy and trade policy?

We are talked a lot about fed policy, but there's a lot driving markets right now, including fiscal policy, including the economy, including inflation, all kinds of feed into the same boat. But when you look at it, even from a broader macro standpoint, there is a good reason to have some defensive investing within your pie charts, within an advisor's pie charts, within your asset allocation. Whether it's on the equity side of the sleeve, you might be going to more dividend paying stocks, or you might be putting structured products in that sector of your allocation. In fixed income, it is twofold — (1) you want to be higher up in credit quality, and (2) you want to have some duration within the portfolio because if this rate cycle continues to go lower, you want to have some yields that are locked in at these present values or even before. That is really what we are looking at, and we are balancing the risks from there.

Strategic Adjustments for Q4 2025 and Into 2026

• Defensive positioning warranted with 1.7% GDP growth and 4.2% unemployment projected for 2025.

• Fixed income strategy: move higher in credit quality and maintain duration to lock in current yields.

• Broader approach includes dividend stocks and structured products on equity side.

Q7. Looking beyond the immediate Fed easing cycle, the Treasury continues to issue substantial debt to fund budget deficits exceeding 6% of GDP, while markets grapple with longer-term inflation risks from structural policy changes. How do these factors influence your outlook for the fixed income landscape over the next 12-18 months?

This kind of dovetails into what we are talking about within the aggregate bond market — the longer-term bond market. While we like the long end to grab some yield and now that we have a normalized yield curve, we want to be careful because the deficits obviously affect the longer end of the bond market much more than the shorter end of the bond market, or the intermediate part of the bond market that tends to be a run-to-safety part of the curve — so we want to be careful about that. We want to have some yield out there in that part of the market, but we also want to be focused on that defensive investing in the front end of the market, where we think we will both be a safe haven for investors if we start to see some volatility in the market and also be great liquidity for investors.

Long-Term Outlook Amid Fiscal Deficits and Structural Policy Risks

• Budget deficits exceeding 6% of GDP create pressure on long end of bond market.

• Normalized yield curve offers opportunities, but deficit concerns warrant caution on duration extension.

• Focus on defensive positioning in front/intermediate curve for safe haven and liquidity while selectively capturing yield.

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Supporting notes for data figures at the date of recording:

• Federal Reserve Bank of St. Louis - Federal Surplus or Deficit [-] as Percent of Gross Domestic Product

• CNBC - Fed approves quarter-point interest rate cut and sees two more coming this year

• Federal Reserve Bank of Philadelphia - Third Quarter 2025 Survey of Professional Forecasters

• Federal Reserve Bank of St. Louis - Recent College Grads Bear Brunt of Labor Market Shifts

• Federal Reserve Board - Detecting Tariff Effects on Consumer Prices in Real Time

• Federal Reserve Board - Federal Reserve issues FOMC statement

• Federal Reserve Board - Summary of Economic Projections, September 17, 2025

• Investopedia - OECD Says U.S. GDP Growth to Slow Next Year as Tariffs, Lower Immigration Weigh on Economy

• U.S. Bank: Wealth Management - Federal Reserve cuts interest rates 0.25% and signals additional cuts likely in coming months

• U.S. Bureau of Labor Statistics: The Economics Daily - Consumer prices up 2.9 percent from August 2024 to August 2025

• Fund Flows ($2.2 billion of net inflows): During the week ending September 10, weekly reporting municipal mutual funds recorded $2.2 billion of net inflows, according to Lipper.