Short Duration Commentary Q3 2025

Executive Summary

Global Macro: Resilience Amid Uncertainty

The overarching macro tone is one of cautious optimism. Despite persistent geopolitical tensions, global markets have shown resilience. China’s GDP forecast has been upgraded, and Europe remains stable but vulnerable to fiscal pressures.

The U.S. economy continues to benefit from fiscal support, specifically driven by recent legislation that benefits both companies and individuals (e.g., immediate expensing of capital investments, elimination of taxes on tips and social security benefits).

The U.S. government entered a partial shutdown on October 1, the first in nearly seven years. While most past shutdowns have lasted only a few days, a prolonged shutdown similar to the December 2018 - January 2019 closure increases risks to interest rate-sensitive sectors, regulatory-dependent industries, government contractors, and managed care. In addition, the administration could use the shutdown as an opportunity to further slash the federal government’s workforce with spillover effects.

Central Banks are Navigating Complex Terrain

The Federal Reserve resumed its easing cycle with a 25-basis point rate cut in September and is expected to continue its easing cycle well into 2026 with the market expecting a terminal rate of 3.0%. Chair Powell described the September rate cut as a “risk management move” signaling the Fed is now more focused on stemming labor market deterioration than on inflation containment alone. The Fed’s willingness to de-emphasize achieving their inflation goal will persist as growing labor market risks have become a larger part of their focus in the near term. Future changes to the composition of the Federal Reserve’s membership and/or balance sheet are likely and bear watching.

While the ECB holds steady, the BoJ may need to raise their policy rate. Their divergent paths, however, remain clouded by political uncertainty, challenges to central bank independence, large deficits, and differing concerns over inflation.

Elevated Trade Uncertainty Despite Recent Deals

Recent tariff deals with key trading partners suggest that the risk of further major escalation, ex. China, is limited. Though the administration believes tariffs are justified under the International Economic Emergency Powers Act (IEEPA), legal challenges are expected to continue. While the appellate court ruled that IEEPA-based tariffs are illegal, the administration is appealing to the Supreme Court. Nevertheless, if the Supreme Court rules against the administration, the administration is expected to seek to utilize other trade laws such as Sections 232 of the Trade Expansion Act (national security), 301 of the Trade Act of 1974 (unfair trade practices) and 122 and 338 of the Tariff Act of 1930 (reciprocal tariffs). We believe that the average tariff rate may decline from current levels but importantly will remain in place at a level significantly higher than that which prevailed prior to 2025.

U.S. Labor Market Deteriorating

In our view, the headline unemployment rate masks the true weakness of the overall labor market. For the first time since 2021, there are more unemployed individuals than job openings, marking a shift from a supply- to a demand-constrained labor market.

Reworked immigration policies are shifting the U.S. labor force composition and have the potential to put upward pressure on wage growth which could feed into inflation.

Recent significant negative revisions to the monthly jobs’ numbers are symptomatic of continued softness and highlight distortions we expect to see going forward, reinforcing the narrative of a weakened labor market.

Near-Term Outlook: Constructive on Interest Rates, Cautious on Spreads

While valuations remain rich and sector fundamentals are supportive, we believe any spread widening will continue to be viewed as a buying opportunity by investors. In this environment, we believe portfolio yield or “carry” will be a key driver of returns. Our focus will remain on investing in subsectors that can weather a more pronounced deterioration in the economic backdrop; for example, we favor higher-quality, less cyclical issuers in investment grade corporates and have a bias toward prime-borrower collateral in structured product (ABS, RMBS) securities.

The yield curve will continue to steepen with short-term rates declining, and longer-term rates remaining stable or perhaps drifting higher. We will continue to maintain our “bulleted” yield curve posture and a slightly long duration bias.

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Disclaimer
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