- Resilient, But Not Immune: Two months into the Persian Gulf conflict, the U.S. economy remains resilient and appears better insulated than other regions. Relative energy independence and a service-oriented composition have helped buffer the shock, particularly compared to Europe and energy-import dependent parts of Asia. But the situation remains highly fluid, with the potential to escalate or deescalate quickly, making the duration of the disruption a key driver of the outlook.
- Growth Narrowing: First quarter GDP rebounded to roughly 2% following a shutdown-driven decline in the fourth quarter, but the composition is more uneven. Strength was driven by a surge in business investment, particularly AI-related spending, while consumer activity slowed. This divergence suggests the expansion is increasingly reliant on a narrower set of drivers rather than broad-based demand.
- Inflation Complicates Policy: Inflation has become more uncertain as higher energy prices add to a growing list of supply shocks, from COVID to tariffs and geopolitical conflicts. While this raises the risk of more persistent inflation, our base case remains that these pressures act as a drag on demand rather than a catalyst for sustained core inflation. This dynamic complicates the Fed’s path as growth slows at the margin.
- Uneven Consumer, New Fault Lines: The consumer backdrop remains bifurcated. Higher-income households and AI-linked sectors show resilience, while lower-income consumers face rising pressure from energy and essential costs. Higher tax refunds have provided some nearterm support, but that tailwind is increasingly being offset by rising gas prices. The labor market has cooled to a more balanced state, with slower wage growth limiting income support. AI-driven disruption introduces an additional risk, with the potential to further widen dispersion in employment and consumption.
- A More Fragile Expansion: The U.S. economy continues to expand, but conditions are increasingly uneven. AI-driven investment and relative insulation from energy shocks support growth, while softer consumer momentum and rising cost pressures point to a more fragile demand backdrop. The most likely path is continued but slower expansion, with outcomes increasingly sensitive to geopolitical developments and their impact on inflation and demand.
- Long End Lagged, Income Offset. April reinforced that headline returns can mask meaningful rate volatility. The long end lagged as yields moved higher, while shorter-duration and higher-carry sectors held up better. High quality exposure and income helped offset the move, and TIPS outperformed nominals, reinforcing that the pressure came more from rising inflation expectations than a broad re-rating of real growth. That backdrop was consistent with how we entered the month, slightly overweight duration but focused in the belly, where a more positively sloped curve and improved roll-down continue to offer a better balance of income and risk.
- A Divided Fed, End of an Era. The Fed held rates steady in April, but the story was the split beneath the surface. Three members pushed back against the easing bias, while one favored an outright cut, an unusual level of dissent. The meeting also marked Jerome Powell’s final one as Chair, closing a cycle defined by aggressive tightening followed by a cautious pivot. The signal is clear: a committee increasingly divided on how to balance still-elevated inflation against a moderating growth backdrop.
- Reform, Not Reset. Attention now shifts to Kevin Warsh, who is likely to be confirmed as the next Fed Chair, with Powell potentially remaining on the Board, creating a more complex leadership dynamic. While Warsh has framed his vision around regime change, the more probable outcome is incremental reform. His focus is likely to center on communication, policy frameworks, and how the Fed incorporates evolving dynamics like productivity and inflation modeling. He is expected to be pragmatic and data-dependent, with institutional constraints limiting how quickly policy can shift.
- Higher Bar to Move. Even with new leadership, the near-term path is likely to remain on hold. Sticky inflation and uncertainty around energy and tariffs raise the bar for rate cuts, while the Fed’s consensus-driven structure limits the scope for abrupt change. The early phase of a Warsh-led Fed is more likely to be defined by recalibration, testing new approaches to communication and framework, than by immediate moves in rates.
- Income Leads; Opportunity Follows. The fixed income story remains intact. Yields across sectors are still near the higher end of their 10-year ranges, providing a meaningful income cushion even in a more volatile rate environment. In a market where income is doing most of the work, the focus shifts to how it is captured—favoring a quality bias and an active approach to duration and curve positioning. Should growth slow enough to bring rate cuts back into play by year-end, the market is likely to reprice quickly, creating a more favorable backdrop for fixed income returns in the second half of the year.
- Income Led the Rebound: Credit markets bounced back in April following March’s rate-driven selloff, with high yield leading the way as income and lower duration proved resilient. Securitized sectors again held up well, supported by shorter cash flows and structural protections, while municipal bonds also participated after earlier weakness. The takeaway is straightforward: returns were driven less by improving fundamentals and more by carry in a market still adjusting to higher rates and a late-cycle backdrop.
- Carry Still Carries: With yields resetting higher in March and largely holding in April, income has reasserted itself as the primary driver of returns. All-in yields remain attractive and are higher year-to-date, creating a more compelling entry point across fixed income. Spreads, however, are tight and broadly aligned with stable fundamentals, not a deteriorating outlook. That leaves less margin for error. Credit can absorb some widening, more in high yield than investment grade, but not enough to offset a meaningful deterioration in the macro backdrop. In other words, yields can still carry the day, but only if spreads remain contained.
- Watch, Not Worry: Concerns around private credit are building, driven by weaker underwriting, increased use of payment-in-kind structures, and rising exposure to AI-related disruption. These risks are real and likely to show up through tighter lending conditions and more selective capital availability. That said, the risk of broader contagion remains limited in our view, with any spillover likely to be gradual and contained rather than systemic.
- A Higher-Quality High Yield Market: High yield today is not the high yield of prior cycles. Roughly 59% of the market is now BB-rated, up from about 43% after the Global Financial Crisis, while only about 9% sits in CCC and below. At the same time, approximately 36% of the market is comprised of secured bonds, debt backed by specific collateral, giving investors a higher claim on assets in the event of default. The result is an asset class that has moved up in both quality and structure, reinforcing its role as a strategic allocation within portfolios.
- AI Is Driving Supply: AI-driven capital spending, expected to exceed $700 billion this year, is fueling a surge in corporate bond issuance, particularly from large technology firms. Demand has kept pace, but the scale of supply is beginning to require greater concessions, suggesting that technical factors may play a larger role in spread behavior going forward.
- Constructive, but Selective: We remain constructive on corporate and securitized credit, supported by a resilient U.S. economy where growth continues to be led by business investment. At the same time, this remains a late-cycle environment, defined by tight spreads and rising dispersion. That reinforces our preference for higher-quality exposures and structural support, alongside a continued role for high yield. In this environment, outcomes will be driven less by broad beta and more by active management and security selection.
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
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.
2025 – The economy remained resilient, and inflation stayed sticky, keeping yields elevated but allowing high-quality intermediate maturity bonds to generate solid returns as the Fed cut rates late in the year. Steady growth and improving liquidity supported tighter spreads, driving performance in credit-sensitive areas of the fixed income market.
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, LLC*
*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
