- Consumer Resilient: As we head into fall, the consumer remains resilient, supported by solid wage growth. We expect economic growth to stay slow through year-end though, pressured by softening job momentum and a modest drag from tariffs. Still, there are reasons for optimism.
- Inflation Waves: Inflation is likely to hover near 3% in the near term, with more tariff costs expected to pass through to consumers in the coming months. History shows inflation tends to arrive in waves, raising the risk of another price surge next year.
- Living with Tariffs: Although the U.S. Court of Appeals rejected the administration’s use of the International Emergency Economic Powers Act to justify current trade policy, tariffs will remain in place during the appeal. If the ruling is upheld, an alternative tariff plan is likely ready. The administration is likely to argue that continuing tariffs secures foreign investment commitments and prevents a deficit shock from lost tariff revenue.
- Policy Pivot: In his final Jackson Hole speech, Chair Powell shifted the Fed’s focus from inflation toward weakening labor conditions, signaling that monetary policy may need adjustment. Markets read the speech as a dovish cue for easing this month.
- Fresh Framework: Powell also unveiled the Fed’s review of its monetary policy framework, dropping flexible average inflation targeting while reaffirming the 2% inflation goal and maximum employment mandate. Paradoxically, these changes imply that policy should remain more restrictive to rein in inflation. We continue to expect cautious, gradual rate cuts toward the neutral rate (assuming the Fed remains largely independent).
- Data Dependent: Upcoming employment and inflation data will be critical in clarifying today’s uncertain backdrop. While Fed easing and the One Big Beautiful Bill Act may support the economy in 2026, it’s unclear if these measures will be enough to catch growth—and a renewed inflation wave could complicate the picture.
- Overweight Fixed Income: We maintain a slight overweight. With slow growth and policy uncertainty fueling volatility, fixed income may offer attractive income and potentially competitive risk-adjusted returns versus riskier assets.
- High-Quality Bias: We favor investment grade for its appealing yields and lower sensitivity to the economy. Beyond Treasuries, we see value in investment grade corporates, securitized credit, and municipal bonds.
- Beware the Long End: We remain cautious on duration. Sticky long-term Treasury yields, and a likely curve steepening, make intermediate maturities more compelling. While conditions could support lower long-end yields, persistent inflation and lack of fiscal discipline may offset, keeping upward pressure on long-term yields.
- Fed Independence Risk: Direct political pressure on the Fed, demanding lower rates and replacing Governors with loyalists, erodes the central bank’s independence. Such moves damage credibility, risk policy mistakes, and could push inflation higher, potentially raising borrowing costs and hurting mortgage borrowers. History shows that once lost, credibility takes decades to rebuild.
- Leaning on the Front End: A sign of fiscal dominance is the Treasury’s reliance on expanding bill issuance to fund deficits and refinance debt, while buying back long-term Treasury bonds. This strategy risks weakening monetary policy’s effectiveness and further distorting Treasury markets.
- Looking Beyond the Noise: Confidence could erode suddenly, though the catalyst and timing are unclear. For now, we expect a steeper yield curve, with short-term yields falling more than the long end. This view reflects our assumption that modest productivity gains against weak labor force growth cap potential economic growth near 4% nominal and under 2% real.
- Cautious on Credit Risk: We remain underweight below investment grade bonds as spreads continue to narrow despite slow expected growth. That said, loose financial conditions, stronger index quality, and a manageable maturity wall lessen the urgency for a more defensive stance.
- Craving Attractive Yields: Demand for long-term corporate debt is strong, while issuance remains relatively light as higher quality issuers manage borrowing costs carefully. Pensions and insurers are eager to lock in higher long-term yields, a favorable backdrop for credit investors seeking quality income.
- Quality Control in High Yield: Post GFC, the high yield market has evolved toward BB-rated issuers and away from CCCs. Issuers now average $1B in EBITDA, five times larger than 20 years ago, supporting more stable earnings and cash flow. Adjusted for this higher quality, current spreads may still have room to grind tighter.
- Watch Corporate Leverage: Deregulation and low borrowing costs could spark a wave of acquisitions and LBOs. Since June, companies have announced about $1 trillion in deals, with YTD activity up 25% from 2024. While new debt can fuel growth and tax efficiency, risks include reduced flexibility and higher rate sensitivity in a downturn. Net leverage remains below the 2020 peak, but we are monitoring closely.
- Private Credit Risk: True default risk in private credit may be understated as payment-in-kind and maturity extensions proliferate. These “selective defaults” are often excluded from reported figures, meaning we may be further along in the credit cycle than official data suggests.
- Active Management Required: Attractive yields, late credit cycle dynamics, and a wave of deal making create both risks and opportunities. We remain focused on actively managing credit allocations as conditions evolve.
Fixed Income Indexes Characteristics
The Indexes mentioned are unmanaged statistical composites of stock market or bond market performance. Investing in an index is not possible.
For Index Definitions see: TouchstoneInvestments.com/insights/investment-terms-and-index-definitions
2022 – The Fed embarked on one of its most aggressive tightening paths seen in decades as the inflation rate surged well above their goal. Interest rates rose across all maturities leading to one of the worst years for fixed income returns.
2023 – Inflation fell broadly while the economy grew with the labor market and consumer spending resilient. The Fed paused midyear helping rates and credit spreads fall late in the year and turning returns positive for the year.
2024 – Economic growth continued unabated, driven by consumer spending. Inflation moderated further. The Federal Reserve pause continued until September, after which it cut interest rates three times by a total of 1 percentage point. Bond yields rose in response, resulting in only modest gains for high quality fixed income but better returns for riskier areas of fixed income.
The Touchstone Asset Allocation Committee
The Touchstone Asset Allocation Committee (TAAC) consisting of Crit Thomas, CFA, CAIA – Global Market Strategist, Erik M. Aarts, CIMA – Vice President and Senior Fixed Income Strategist, and Tim Paulin, CFA – Senior Vice President, Investment Research and Product Management, develops in-depth asset allocation guidance using established and evolving methodologies, inputs and analysis and communicates its methods, findings and guidance to stakeholders. TAAC uses different approaches in its development of Strategic Allocation and Tactical Allocation that are designed to add value for financial professionals and their clients. TAAC meets regularly to assess market conditions and conducts deep dive analyses on specific asset classes which are delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800.638.8194 for more information.
A Word About Risk
Investing in fixed-income securities which can experience reduced liquidity during certain market events, lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. Investment grade debt securities which may be downgraded by a Nationally Recognized Statistical Rating Organization (NRSRO) to below
investment grade status. U.S. government agency securities which are neither issued nor guaranteed by the U.S. Treasury and are not guaranteed against price movements due to changing interest rates. Mortgage-backed securities and asset-backed securities are subject to the risks of prepayment, defaults, changing interest rates and at times, the financial condition of the issuer. Foreign securities carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. Emerging markets securities which are more likely to experience turmoil or rapid changes in market or economic conditions than developed countries.
Performance data quoted represents past performance, which is no guarantee of future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than performance data given. For performance information current to the most recent month-end, visit TouchstoneInvestments.com/mutual-funds.
Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.
Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.
Touchstone is a member of Western & Southern Financial Group
Not FDIC Insured | No Bank Guarantee | May Lose Value
