- Capex Offsets Slower Consumption: Economic growth remains resilient despite softer consumer spending. First-quarter GDP was revised lower as household consumption slowed, but rising business investment helped offset the weakness. Continued spending on semiconductors, data centers, power infrastructure, and related projects has supported manufacturing activity and helped keep economic growth near its long-term trend.
- Consumer Showing Strain: The labor market remains supportive, with job growth improving and unemployment remaining stable. However, consumer spending has moderated, and the personal savings rate has fallen to levels not seen since the Global Financial Crisis. Higher energy and essential costs are placing increasing pressure on household budgets, leaving consumers with less flexibility than in recent years.
- Inflation Broadens Beyond Energy: While energy prices remain the most visible source of inflation pressure, AI infrastructure spending is beginning to create bottlenecks across parts of the global supply chain. Demand for semiconductors, high-bandwidth memory, power equipment, data center construction materials, and electrical infrastructure has accelerated sharply. Although AI may ultimately prove disinflationary, the buildout phase is contributing to near-term price pressures. As a result, progress toward the Federal Reserve's inflation target has stalled, with core PCE inflation rising back to 3.3% year over year. The likelihood of additional rate cuts is low.
- Energy Markets Remain Vulnerable: The global economy has absorbed the disruption to Middle East energy supplies better than initially feared. Alternative transportation routes, increased production elsewhere, inventory drawdowns, and demand destruction in Asia have helped offset lost supply and limit the near-term impact on global growth. However, energy markets remain vulnerable as inventories continue to decline and uncertainty surrounding the Strait of Hormuz persists. Even if a resolution is reached soon, elevated energy and transportation costs may continue
to influence inflation for several months. - Resilience Supports Financial Assets: Stable labor markets, continued AI-driven investment, and positive economic growth support financial market returns. Strong corporate earnings and ongoing capital spending have helped counter concerns surrounding inflation and higher energy costs. Risks have become more balanced, and the current environment continues to favor risk assets, provided economic resilience and AI-related growth remain intact.
- Income Gains Offset Price Losses: Bond prices fell during May before recouping some of the losses late in the month as optimism surrounding a potential Strait of Hormuz resolution resurfaced. Treasuries lagged, while investment grade corporates and securitized sectors gained, benefiting from higher absolute yields and tighter spreads. This outcome was broadly consistent with our positioning: a slight overweight to duration focused in the intermediate portion of the curve and overweight higher-quality spread sectors.
- Fed Consensus Likely Prevails: While incoming Fed Chair Kevin Warsh may bring a different perspective to the Federal Reserve, changing leadership does not necessarily mean changing policy. Inflation remains above target, labor markets have stabilized, and AI-driven investment continues to support economic activity. We expect the committee to remove its easing bias as early as the next meeting and potentially adopt a tightening bias should inflation pressures broaden further. Markets appear increasingly aligned with this view, with forward markets now pricing a higher-for-longer policy path and even the possibility of additional tightening by spring 2027.
- Higher Rates, Anchored Expectations: Treasury yields remain elevated, but the market's message has evolved. While inflation concerns pushed yields higher during March and April, inflation expectations moderated in May. The recent parallel shift higher in the yield curve suggests markets are repricing the expected path of short-term interest rates rather than forecasting an unchecked rise in long-term inflation that would require even higher long-term yields. The decline in breakeven inflation rates during the second half of May reflects confidence that a higher-for-longer policy stance can keep inflation expectations anchored.
- The Risk Is Persistent Inflation: Inflation pressures are no longer confined to energy markets. AI-related capital spending is beginning to create supply constraints across semiconductors, memory, power infrastructure, and industrial equipment. While the long-term impact of AI may ultimately be disinflationary through productivity gains, the infrastructure buildout required to support it appears inflationary today. This dynamic could lift inflation higher than markets currently anticipate and reinforces a higher-for-longer stance by the Fed.
- Yield Remains the Story: Despite recent volatility, we continue to view high-quality fixed income favorably. Yields remain near the upper end of their 10-year ranges across most investment grade sectors, providing a meaningful income cushion. We continue to favor the intermediate portion of the curve and higher-quality corporate and securitized credit, where we believe investors are being best compensated for risk.
- Solid Month for Credit: Credit-sensitive sectors performed well in May as resilient economic growth, healthy corporate fundamentals, and continued demand for income supported valuations. Strong business investment, particularly AI-related spending, continues to support corporate earnings and cash flows. Combined with attractive yields, this has provided a supportive backdrop for credit markets.
- A Different High Yield Market: We are moderately underweight below-investment-grade credit, reflecting historically tight spreads and limited compensation for macroeconomic risks. However, today's high yield bond market differs meaningfully from prior cycles. Lower-quality borrowers have increasingly migrated toward leveraged loans and private credit, leaving the public high yield universe materially higher in quality than it was following the Global Financial Crisis. BB-rated issuers now represent a majority of the market. This evolution supports selective exposure to below-investment-grade bonds even while overall valuations argue for caution.
- Dispersion Increasing: While broad credit fundamentals remain supportive, conditions beneath the surface are becoming more differentiated. Higher quality bonds continue to outperform lower-quality leveraged loans, while CCC-rated borrowers face mounting pressure from elevated financing costs, refinancing challenges, and business-model disruption. Credit spreads at the index level continue to imply healthy fundamentals but increasingly mask meaningful differences across sectors, issuers, and capital structures. As dispersion widens, security-level analysis becomes increasingly important.
- AI Creating a New Credit Cycle: Artificial intelligence is increasingly influencing credit markets through both capital spending and debt issuance. Debt raised to finance data centers now accounts for an estimated 17% of U.S. high yield bond issuance this year, a greater concentration than energy- related issuance reached during the shale boom of the mid-2010s. While the comparison highlights the scale of today's investment cycle, the opportunity set extends well beyond technology into utilities, industrials, infrastructure, and other sectors supporting the AI ecosystem. As capital flows toward these investments, investors must distinguish between issuers building durable competitive advantages and those unlikely to earn adequate returns on invested capital.
- Constructive, but Selective: We remain constructive on credit risk, supported by resilient economic growth, healthy corporate fundamentals, and yields that remain attractive after inflation. At the same time, tight spreads and growing dispersion reinforce the importance of selectivity. The broad credit market still appears fundamentally sound, but opportunities are becoming increasingly issuer-specific rather than market-wide. In our view, this remains an environment where income matters, fundamentals matter, and active management matters even more.
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
