Geopolitics, Cooling Inflation and Rising Risk Appetite Shape Q2 Fixed-Income Outlook

Yields are sinking to their lowest levels in nearly a month as a flurry of cross country occurs hit the fixed income.

Now on one hand, geopolitical tensions remain high as Trump's naval blockade of Iran continues, but on the other side, risk appetite is returning to Wall Street on hopes that diplomats can broker a peace deal and reopen the Strait of Hormuz eventually and add in a cooler than expected March. inflation report and resilient earnings from the big banks and suddenly the markets are ramping up bets on a more dovish buys from the Federal Reserve.

Well joining me this morning to weigh in is Mike Goosay, the CIO & Global Head of Fixed Income at Principal Asset Management.

My great.

Thank you so much for joining me.

Thank you.

Well here we are starting off the second quarter of 2026 and we have a better hold on what's happening.

Here in the US in terms of inflation and that will also affect the Fed rate outlook, but we have geopolitical tensions simmering.

So how does that affect your bigger outlook?

Yes, it's a complicated one because you know as investors we try to try to look through some of the noise and the geopolitical noise is hard to look through right now.

Inflation was a concern and certainly still will remain one.

As energy prices remain elevated, but as we kind of go forward, what we think the Fed is going to lean into is the expectations that the employment picture is deteriorating, that inflation, although maybe not back at the Fed's target 2% level, is certainly getting close, and that this inflation risk associated with energy prices could be a bit more transitory, to use that four letter word from a few years ago.

And so as a result, we think the Fed is more likely to cut policy rates than hike, and that the bond market is mispricing, at least in the near term, the likelihood of Fed cuts.

That's interesting you mention that because all of us have been paying attention to volatility across all asset classes, but when it comes to US bonds and in particular yields, tell us what you're seeing both on the short and the long end.

So long ends are going to be the end of the curve is going to be more sensitive to inflation expectations or the front end is going to be more sensitive to change in funds rates.

What we have seen for a while.

Was that there were more and more cuts getting priced into the market pre this geopolitical environment and the uncertainty about what war in Iran could mean, how that could play out in terms of commodity prices, what that could mean longer term in terms of the U.S.'s place in the world, and demand for US dollar assets really challenged the entirety of the yield curve, but much more so the front end.

The curve where the market started to price in risks of Fed hikes again, we think that's misplaced and that the more likely path is to see Fed cuts, but the long end is likely to be more sensitive to inflation risks which, although have come down, are still elevated.

And so we think the curve should steepen, that long end should underperform that intermediate and shorter end of the curve as we go through the remainder of this year.

And Mike, one thing we have to remember is today is April 15th, and that is tax day, and many Americans may be taking a look at their capital gains or their portfolios.

So when it comes to the sweet spot, when it comes to bonds, I understand the 5 to 10 year range is the sweet spot.

So tell us why.

So you tend to see the most attractive. and carry associated with that part of the curve, which means as bonds get closer to maturity, you wind up seeing them roll down the curve because Treasury curves are generally upward sloping, so that part of the curve tends to have the best excess return potential in a neutral rate-like environment.

But as you get to tax day, what's interesting is how investors think about.

Raising cash to pay their tax bill and a lot of the times you want to avoid taking too many gains because then you're just building another tax problem for next year.

Bonds haven't done that well over the last year, and so some of the pressure more recently could be attributable to some investors selling down some fixed income assets to pay for their tax bill due today.

And I do want to take a trip around the globe and look at emerging markets.

So what are we seeing when it comes to bonds and yields and EM emerging market countries generally are a bit more sensitive to this geopolitical risk.

We've seen a pretty good rally in the US dollar, and that has come at the expense of some of the other developed countries like the euro, the pound, the yen, but you see it much more acutely in some of these emerging countries where they're much more sensitive to changes.

Interest rates, geopolitical risks, and when the dollar rallies, you tend to see those emerging countries really underperform.

We think that's creating an opportunity more than something to run away from.

These are countries that are in a much better fiscal position than they've been in quite some time.

We think the global economic backdrop, although a little weaker, is still OK.

And so these countries over time tend to be commodity exporters.

They tend to be manufacturing hubs, and we think are likely to do well as we go through the remainder of this year.

And Mike, I know you focus on fixed income, but I think the role of the US dollar plays an important part here because heading into the beginning of this year we're talking about diversification and the outperformance of markets outside of the US, but here we are in Q2 of 2026 and we're watching the US currency where it is right now.

So what are the implications for equity markets and what are you paying attention to?

So I am a fixed income person, so I try to steer clear of the equity comments, but I'll try to put them in fixed income terms, which is around corporate bond spreads.

So corporate bond spreads tend to behave more like equities, and as a result, when you get an environment like we've been dealing with, which is very headline driven.

Very focused on what tweet is coming out or what news story is going to be hitting the tapes, it becomes less about the quality of those companies and more about fear in the markets.

Longer term, we think that quality companies should continue to appreciate, see tighter spreads, and ultimately better equity values.

And Mike finally bringing this discussion back to the US.

Let's talk about Mui bonds here.

So what are the best defensive plays in Munis?

So municipal bond securities are very attractive right now.

They've actually had a bit of a rough run in the last couple of months.

There's been some, you know, excess volatility in the market, and Munis tend to behave poorly in that type of environment.

But we try to look at more revenue oriented assets rather than general obligation bonds.

So think about things that are like toll roads and water and sewer stuff that there's money collected by the municipality and that goes to pay off that debt rather than just general obligation bonds.

So we think that's an attractive way to look at the market.

But overall the municipal bond market is really attractive on its own merits but also in comparison to taxable fixed income assets.

And that leaves me with my last question.

We have about 60 seconds here, so today is tax day, and I'm sure many people are looking at their portfolio and their investments.

So bottom line advice for fixed income investors who are looking ahead to the rest of 2026.

What would you say to them?

So for the first time in a while we've seen income at a fixed income.

You know, traditionally you get a coupon, you get your money back with fixed income, but call it COVID.

Through a couple of years ago we really had very little yield in the fixed income market.

So I would suggest to investors think about that income in your portfolio.

You're able to enjoy 56, in some cases 7% yields in the fixed income market, and that's comparable to what you can get in traditional equity returns over time.

So focus on income and put more money in bonds.

Mike, it was great having you here.

Thank you so much for weighing in.

I appreciate your time and all of your insights.

Thank you.