- Uneven, Not Unraveling: Economic growth remains resilient, but September reinforced that strength is uneven. Manufacturing and business investment continue to expand, supported by AI-related spending, while housing and more indebted consumers remain pressured by elevated borrowing costs. More recently, the sharp rise in market yields since summer has tightened financial conditions further, but it is too early to know how much additional restraint that will place on economic activity.
- Jobs Downshift: September payroll growth slowed, with prior months revised lower and wage growth moderating. The unemployment rate edged up slightly, while layoffs and weekly unemployment claims remain subdued. We see the report as evidence of a low-hire/low-fire labor market rather than a deterioration in employment.
- Scrappy Consumer: Consumer spending continues to hold up despite slower wage growth, low savings and higher borrowing costs. Households have increasingly traded down and stretched budgets, while higher gas prices continue to drag on purchasing power. For now, employment and income continue to support consumption, but the consumer has less cushion should the labor market weaken further.
- Inflation Cooler, Not Conquered: Recent inflation readings have improved after the reacceleration earlier this year. That relief may prove temporary as manufacturers continue to report elevated energy, transportation and raw material costs. The recent improvement is encouraging, but not yet enough to establish that inflation is on a sustained path back to the Federal Reserve's 2% objective.
- Pause, Not Pivot: Tighter financial conditions, including higher borrowing costs and modestly wider credit spreads, may reduce the urgency for another near-term rate hike by doing some of the Fed's work. But a pause should not be mistaken for a pivot. The Fed rarely pursues a “one and done” tightening strategy, and inflation remains high enough to keep additional rate hikes on the table if economic conditions warrant.
- Measured Risk-Taking: Healthy corporate earnings and continued AI investment support TAAC's moderate overweight to equities and recent increase in large-cap growth. At the same time, tighter financial conditions argue against becoming more aggressive. Within fixed income, higher yields improve prospective returns while supporting our neutral duration stance and preference for higher-quality corporate and securitized credit.
- Real Yields Send a Signal: September's bond selloff was driven largely by rising real yields rather than a surge in long-term inflation expectations. The 10-year Treasury moved above 5%, while 10-year TIPS yields approached 3% and breakeven inflation remained contained. Inflation and Fed policy aside, investors appear to be demanding a higher real return to commit capital, further evidence that the market may be repricing the underlying cost of capital.
- One Framework, Many Forces: Strong growth, higher commodity prices, Fed tightening, fiscal deficits and AI-related borrowing have all been cited as reasons for rising global bond yields. While these forces differ, many share a common thread: more borrowers are competing for capital while investors have more choices. Large government financing needs are arriving alongside substantial private investment, increasing competition for available savings, while higher sovereign yields globally provide additional alternatives. We believe this represents a regime change, one in which borrowers may need to offer persistently higher yields to attract price-sensitive investors.
- A Buyer's Market: The Treasury buyer base has shifted away from relatively price-insensitive investors such as the Fed and foreign central banks toward private investors. With more price-sensitive buyers setting the marginal price, investors can demand higher yields to commit capital. It is becoming a buyer’s market, much like shopping online when competing sellers are fighting for the same customer.
- Higher Yields, Better Opportunity: Higher starting yields provide more income to absorb rate volatility and greater potential price appreciation should economic growth weaken. A structurally higher clearing rate does not mean yields only move higher: if growth slows, inflation moderates or demand for capital weakens, real yields can fall around that higher long-run anchor. Investors can earn meaningful income while the market searches for its new equilibrium.
- Neutral, Not Passive: Our August move from a slight duration overweight to neutral reduced interest-rate exposure ahead of the subsequent rise in Treasury yields. Starting yields are now considerably more attractive, but uncertainty around the new market-clearing rate argues against immediately extending duration. We remain neutral, favor intermediate maturities and would consider adding duration as evidence builds that higher real yields and tighter financial conditions are slowing economic activity.
- A Better Deal for Lenders: A buyer’s market is beginning to improve the economics of new credit issuance even as secondary-market spreads remain relatively tight. Capital-intensive borrowers are increasingly offering wider pricing, discounts and, in selected deals, stronger lender protections to attract financing. For active managers willing to be selective, the primary market can therefore offer better risk/reward than broad credit valuations suggest.
- AI Raises the Stakes: AI-related financing continues to expand across investment-grade, high-yield and private credit markets, creating both opportunity and risk. As debt increasingly finances the buildout, investors must look beyond the issuer to the economics and structure of each transaction. Strong demand for compute remains supportive, but power availability, construction risk, leverage and dependence on a relatively small group of counterparties make careful underwriting increasingly important.
- Cash Flow Has Value: The sharp rise in short-term yields has made the timing of cash flows increasingly important. Many securitized assets return principal throughout their lives through amortization and repayments, giving managers capital to reinvest as opportunities arise. With reinvestment rates having risen substantially since spring, those recurring cash flows can now be redeployed at meaningfully higher yields. We continue to favor select ABS, CMBS and seasoned non-agency RMBS, where diversified collateral and structural protections complement this reinvestment advantage.
- Watch the Weak Links: Stress has become more visible at the lower end of the credit spectrum. CCC spreads widened sharply relative to BB and single-B bonds during September, although much of the move appears concentrated among a relatively small group of weaker issuers. Private credit is also showing more “soft defaults,” including extensions and negotiated restructurings. These remain warning signs rather than evidence of broad credit stress, but we are watching closely for signs that tighter financial conditions are spreading to stronger borrowers.
- Quality Over Beta: Higher Treasury yields have lifted all-in bond yields meaningfully, even as credit spreads remain relatively tight. We continue to favor higher-quality corporate and diversified securitized credit, where attractive income can be paired with greater selectivity in issuer, maturity and structure. We remain underweight high yield, preferring to harvest income without reaching indiscriminately for credit risk.
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 Erik M. Aarts, CIMA – Vice President and Senior Fixed Income Strategist, James Macey, CFA, CAIA – Assistant Vice President, Global Market Strategist, Tim Paulin, CFA – Senior Vice President, Investments and Practice Consulting, and Crit Thomas, CFA, CAIA – Global Market Strategist, 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
