Quarterly Perspectives 3Q 2026

Third Quarter Market Summary 

UST yields rose sharply in the third quarter as investors recalibrated expectations for inflation, monetary policy, economic growth and federal borrowing needs. Fed Chair Warsh reinforced a more hawkish policy outlook in both his speech at the late-August Jackson Hole Economic Policy Symposium and again following the September FOMC meeting, at which the Committee tightened policy for the first time in more than three years.

The UST rate selloff pushed the yield to worst on the Bloomberg U.S. Aggregate Bond Index (the Agg) up to 5.56%, resulting in a negative 3.51% total return. Changes in risk premia were relatively subdued, with the option-adjusted-spread (OAS) for the Agg widening 5 bps to 31 bps. 

The spike in rate volatility weighed heavily on MBS, which experienced excess returns of -1.16% and significantly underperformed other IG sectors. ABS was the only sector to achieve positive excess returns, buoyed by its short duration and high-quality attributes (Figure 1).

Figure 1. Third Quarter Excess Returns, Bloomberg U.S. Aggregate and U.S. Corporate High Yield Indices

As of 9/30/2026. Source: Bloomberg L.P. View accessible version of chart.
1 Excess return: Shows the excess total return of each index/component of the index relative to the duration-matched UST Index.
2 OAS of the Bloomberg U.S. Aggregate Index. 
3 CMBS: Commercial Mortgage-Backed Securities; ERISA: Employee Retirement Income Security Act of 1974

Monetary and Fiscal Policy — Competing Agendas

At the Fed's Jackson Hole Economic Policy Symposium, Chair Warsh emphasized that inflation remaining above the Fed's 2% objective requires policymakers to have a predominant focus on price stability. He also asserted that prevailing financial conditions were not meaningfully restrictive, implying that the current policy stance was not sufficiently tight to return inflation sustainably to target. The market reaction was swift, with the UST selloff accelerating from late August through September as the projected path of policy rates shifted higher (Figure 2). Rate volatility spiked in tandem with yields, reflecting greater uncertainty around both the timing and magnitude of additional tightening.

Figure 2. UST Yield Curve Changes by Maturity

As of 9/30/2026. Source: Bloomberg L.P. View accessible version of chart.

While the market had discounted the FOMC's rate hike at the September meeting, Chair Warsh's post-meeting press conference comments were considerably more hawkish and built on his speech at Jackson Hole. Warsh described the hike as “removing accommodation,” which suggests he viewed the neutral rate for the economy as trending higher. The Fed's Summary of Economic Projections illustrated that 16 of 18 participants anticipated at least one additional 25-bp increase in 2026, including four who projected two further increases. Forecasts for the next several years also suggested a need for tighter policy: the median participant projected no cuts in 2027 and a policy rate above the longer-term “neutral” rate through 2029.

The Fed is confronting supply-side pressures that are impacting supply chains and input costs during a period of robust capital investment. These pressures include tariffs, higher prices for oil, refined products, feedstock and agricultural commodities, as well as elevated transportation and shipping costs. When these shocks occur in succession after inflation has exceeded target for such an extended period, policymakers have less latitude to treat them as temporary. 

From a fiscal policy perspective, Treasury Secretary Scott Bessent has assumed a more active role in global capital markets in an effort to help limit further increases in longer-term UST yields. In July, Secretary Bessent coordinated a currency intervention to support the yen and alleviate pressure for policymakers in Japan to sell USTs. Then, in August, he announced a significant expansion of UST buybacks, a program designed to regularly repurchase USTs to support market liquidity. Later, Secretary Bessent reaffirmed these policies by declaring “I am the house now” in September, an apparent challenge to capital markets to test his resolve. That said, many investors remain skeptical that these policy actions will be effective tools in managing the yield curve.

Portfolio Positioning — Favorable Yield Symmetry

During the quarter, significant corporate issuance created select opportunities to add exposure through new-issue concessions and steeper credit curves. Valuations remain expensive, so we seek to maintain a generally neutral risk position, preserving our capacity to add exposure should risk premia become more compelling. That said, higher yields broadly may help to limit spread widening, as all-in yields are compelling. As of September 30, the yield to worst was 6.04% for the Bloomberg U.S. Corporate Index and 8.35% for the Bloomberg Corporate High Yield Index, offering a competitive alternative to equities and attractive return symmetry.

MBS ended the quarter under significant pressure as the persistent rise in rates and a spike in volatility pushed spreads wider. The sector generated an excess return of -96 bps in September, its weakest monthly performance since September 2023. Relative underperformance was broadly consistent across the coupon stack over the past three months, although 15-year pools materially outperformed 30-years. After quarter end, the market has stabilized somewhat but has continued to trade cautiously.

Production-coupon spreads widened approximately 15 bps during the month, to 129 bps more than USTs, the widest level of the year. At the same time, the 30-year fixed mortgage rate increased to 7.3%, which has effectively removed refinancing incentives, extended index duration by nearly half a year to approximately six years, while further weighing on housing market turnover.

Until rates stabilize, the MBS market is likely to remain challenged in our view, as duration and convexity concerns continue to outweigh otherwise compelling relative value. Technicals remain supported by low organic supply and the potential for government-sponsored enterprise (GSE) support. Despite the White House's January directive authorizing the GSEs to increase their balance sheets by $200 billion, year-to-date purchase activity has trended below street estimates. Additions slowed in May but current spreads may incentivize an increase in activity.

ABS have delivered strong year-to-date performance and outperformed high-quality credit with less volatility, fulfilling their intended role in portfolios, where we remain overweight (Figure 3). This dynamic has occurred despite robust new issuance that is steadily outpacing last year's supply.

Figure 3. Year-to-date Rolling Excess Returns: ABS vs. Short Credit

As of 9/30/2026. Source: Bloomberg L.P. View accessible version of chart.

Outlook — A Confluence of Challenges 

Looking ahead, financial markets are eager for the recent volatility in global bond markets to abate. Domestically, the rise in UST yields has been driven primarily by higher real rates and an increase in term premia as TIPS break-evens have remained relatively stable (Figure 4). This dynamic suggests that markets are increasingly expecting the Fed to not only tighten policy further, but also to keep rates elevated for longer to contain inflation. 

Figure 4. Year-to-date UST Yield Change

As of 9/30/2026. Source: Bloomberg L.P. View accessible version of chart.

Resilient growth and robust capital investment, particularly in technology infrastructure, are increasing demand for capital and reinforcing the case for restrictive policy. At the same time, policymakers must weigh the near-term inflationary pressures associated with surging AI-related investment against the potential for longer-term productivity gains to improve supply and moderate inflation.

The labor market presents a more mixed outlook. The unemployment rate has remained steady, and monthly job growth near 50,000 appears sufficient to keep it stable. However, the continued rise in long-term unemployment points to underlying weakness. Workers are finding it more difficult to enter or reenter the labor force, and job gains remain concentrated in healthcare and social services, conditions that are not fully consistent with otherwise robust economic growth. 

Against this backdrop, we expect episodic interest-rate volatility and favor more tactical adjustments to portfolio positioning. Given yield symmetry, we believe a neutral duration position is warranted, while we source selective exposure to corporate credit. We also maintain that an overweight to structured products can offer opportunities to enhance income and improve total return. At current spreads, the agency MBS sector offers a more attractive excess return profile after recent underperformance, but a more durable opportunity will likely require greater stability in rates.

The higher yield environment has improved the opportunity set for fixed income investors by creating more favorable return symmetry. The carry benefit can provide meaningful protection in short- and intermediate-duration strategies, reducing the likelihood of outright losses over a one-year holding pattern even if rates rise further (Figure 5). 

Figure 5. 12-mo. Total Returns in Different Interest Rate Scenarios*

As of 9/30/2026. *Assumes a parallel shift in the yield curve. Source: Bloomberg L.P. View accessible version of chart. 

Figure 1. Third Quarter Excess Returns, Bloomberg U.S. Aggregate and U.S. Corporate High Yield Indices

Figure 3. Year-to-date Rolling Excess Returns: ABS vs. Short Credit