Day Hagan Smart Sector® Fixed Income Strategy Update August 2025
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Day Hagan Smart Sector® Fixed Income Strategy Update August 2025 (pdf)
Executive Summary
In July 2025, U.S. and global fixed income markets moved within a complex environment shaped by central bank decisions, economic updates, fiscal signals, and geopolitical developments.
The Federal Reserve maintained its policy rate steady at 4.25–4.5% in July, adhering to its “higher for longer” message while continuing to adopt a data-dependent approach. While bond markets speculated about potential policy easing later, the Fed avoided signaling immediate rate cuts.
U.S. Treasury yields were relatively stable through the month. The 10-year Treasury yield began July near 4.26% (July 1), ranged between 4.30%–4.50% much of the month, and finished at 4.37% on July 31. Yields edged higher overall, with some intra-month volatility. This kept total returns subdued for core government bonds.
Investment-grade corporate bonds saw spreads remain tight, around 83–85 basis points—near historical lows—reflecting ongoing investor demand for quality income despite economic uncertainty. High-yield bond spreads edged slightly higher in late July, surpassing 300 basis points as risk sentiment softened, though demand was steady earlier in the month.
Mortgage-backed securities (MBS) produced modest but positive returns, generally lagging investment-grade corporates. Despite steady credit performance, the sector continued to contend with affordability challenges and mild pressures from housing market softness.
Inflation-protected securities (TIPS) traded in a narrow range, with inflation expectations remaining largely unchanged. Demand for inflation protection remained moderate, with a focus on medium-term hedging.
Internationally, investment-grade government bonds benefited from stable to accommodative central bank stances in Europe, as well as some improvement in fiscal outlooks. Emerging market debt saw continued inflows, supported by rate cuts from many EM central banks and a broadly weaker U.S. dollar, helping local currency bond performance despite ongoing geopolitical risk.
In summary, July’s fixed income market reflected a steady monetary policy backdrop, strong demand for high-quality credit, and more nuanced outcomes for risk and inflation-linked assets. Shorter-duration and floating-rate products benefited from yield stability; credit markets basked in tight spreads; and returns for government and inflation-protected securities reflected the impact of persistent but moderate interest rate and inflation expectations.
Holdings
Fixed Income Sector
US 1-3 Month T-bill
US 3-7 Year Treasury
US 10-20 Year Treasury
TIPS (short-term)
US Mortgage-Backed
US Floating Rate
US Corporate
US High Yield
International Corporate Bond
Emerging Market Bond
Outlook (relative to benchmark)
Overweight
Neutral
Neutral
Neutral
Neutral
Underweight
Neutral
Neutral
Underweight
Modestly Overweight
Position Details
U.S. Treasuries: Shorter-duration Treasuries are favored. Technical measures of trend, momentum, and CDS rates are negative for longer-term bonds. Given that the Fed is likely to lower rates by September, we have lowered duration by adding to our shorter-term maturities.
Commentary: The Federal Reserve was front and center: at its July meeting, the Fed held policy steady, keeping the federal funds rate at 4.25–4.5% and maintaining a measured pace of balance sheet runoff. Fed officials emphasized their focus on incoming data amid persistent inflation and softening job growth but stopped short of signaling imminent easing. Economic releases notably influenced Treasuries. The July jobs report fell well short of expectations, with only 73,000 jobs added and previous months’ numbers revised sharply downward. The unemployment rate ticked up to 4.2%, fueling recession worries and pushing yields lower as the market began pricing in a higher likelihood of a rate cut at the Fed’s next meeting. On the supply side, Treasury auctions saw robust participation, with high bid-to-cover ratios—evidence that, despite a surge in new issuance (driven by growing deficits), there was solid demand for short- and medium-term paper. However, the growing fiscal deficit and expectations of further supply kept some upward pressure on longer-dated yields. Meanwhile, ETF flows reflected healthy demand for Treasury securities, particularly at the short end, where funds like the iShares 0-3 Month Treasury Bond ETF drew substantial inflows as investors sought safe yield without duration risk. In summary, July’s Treasury market was buffeted by softening labor data, the Fed’s steadfast policy, heavy auction supply, and strong ETF demand, keeping yields volatile but range-bound as investors weighed growth fears against mounting deficits.
Figure 1: Strength in the U.S. dollar is supporting foreign investment.
U.S. TIPS: The TIPS composite model was unchanged in August. Measures of trend, inflation expectations (which are moving higher), tight high-yield option-adjusted spreads, and commodity price trends are all bullish. Conversely, OBOS indicators indicate overbought conditions are in place and upside momentum is slowing. We are neutral.
Commentary: In July 2025, the U.S. TIPS (Treasury Inflation-Protected Securities) market found itself at the crossroads of evolving inflation expectations, shifting economic data, and consequential policy decisions. While much attention remained focused on the headline CPI, investors in TIPS were particularly attuned to the persistent, albeit modest, uptick in core inflation, which reached 2.7% by June. This inflation trajectory, compounded by the tariff extensions and uncertainty surrounding future trade policy, kept demand for inflation protection relevant even as the overall disinflation narrative persisted. Auction dynamics stood out, with July TIPS offerings drawing solid, if cautious, interest. Bid-to-cover ratios reflected an investor base eager for inflation-linked income but also wary of additional supply and longer-term fiscal risks. ETF flows mirrored this trend: TIPS-dedicated funds saw mixed activity as some investors rotated out of nominal Treasuries into inflation-linked products, hedging both near-term price pressures and any surprises from ongoing tariff negotiations. Amid this backdrop, TIPS real yields moved moderately, oscillating as investors digested mixed signals from labor reports, commentary from Fed officials, and expectations for future rate adjustments.
Figure 2: Inflation expectations are perking up but expected to be transitory.
U.S. Mortgage-Backed Securities: The composite model improved with OBOS, yield trends, inflation expectations, and tight high-yield option-adjusted spreads, all of which are bullish. Longer-term trend indicators remain negative but are on the verge of triggering buy signals. We are increasing exposure.
Commentary: The Federal Reserve’s July meeting, while maintaining steady rates, featured its first dissenters in over three decades, signaling a subtle shift in central bank unity and prompting market participants to re-evaluate risk and duration in mortgage assets. Despite no immediate Fed rate cut, declines in longer-term Treasury yields propelled MBS prices modestly higher, aided by soft economic releases, including subdued retail sales and growing signs of consumer stress. MBS supply remained heavy, with the New York Fed conducting approximately $81 million in small-value sale operations over the second half of July, as part of its ongoing portfolio runoff. Meanwhile, outstanding credit performance was steady, but analysts flagged rising negative equity, affordability concerns, and elevated student loan burdens among U.S. homeowners as emerging risks. These macroeconomic headwinds kept MBS spreads tight but susceptible to widening in the event of negative economic surprises. ETF flows into the MBS sector saw mild inflows, reflecting cautious optimism among investors seeking yield without the added volatility found in corporate credit. Yet, uncertainty around future prepayment speeds—tied closely to mortgage rates and refinancing prospects—kept some buyers on the sidelines. Overall, July presented a cautious balancing act for the MBS market, as investors weighed the volatility of interest rates, steady credit performance, and the gradual unwinding of central bank support.
Figure 3: Tight High-Yield OAS support MBS.
U.S. Floating Rate Notes: The composite model deteriorated into August and is now negative. Trend indicators are negative, confirmed by the lower OIS swap rate (indicating expectations for Fed easing). A higher VIX often indicates risk-off sentiment, which historically favors Treasuries over FRNs. We are now underweight.
Commentary: With the Federal Reserve maintaining the policy rate and signaling a “higher for longer” stance on rates, demand for FRNs grew, thanks to their weekly-reset coupons, which allowed investors to capture rising short-term rates while minimizing duration risk. Market participants were attentive to economic releases, especially robust Treasury bill auction results; the 13-week T-bill discount rate, which underpins FRN coupon resets, hovered around 4.24% in July. Strong auction demand drove competitive spreads, with average yields on FRNs near 4.35–4.50%, outpacing many fixed-rate bonds, especially as recession fears kept a lid on long-dated Treasury demand. Sector trends were also notable: investment-grade issuers in utilities, healthcare, and finance dominated new FRN supply, seeking to tap low-cost funding despite future rate uncertainty. ETF flows, particularly into funds like FLOT, reflected a defensive rotation into FRNs as investors sought both principal preservation and adaptive income. Ultimately, July’s environment—characterized by steady Fed policy, resilient economic signals, and robust auction execution—kept U.S. FRNs in the spotlight as a low-volatility, yield-enhancing alternative that protected portfolios from the price depreciation facing longer-duration assets.
Figure 4: Lower OIS swap rates indicate investors setting up for rate cuts. The recent move is minimal but closing in on the recent lows for the series since 2023.
U.S. IG Corporates: The composite model improved. Tighter CDS, strength in the U.S. dollar since July 1, and positive trend reversals are bullish. We are increasing exposure to neutral. A reversal in bond volatility, confirmed by more technical indicators turning positive, would cause us to further increase exposure.
Commentary: Credit spreads tightened, reaching multi-year lows of around 83–85 basis points, as investor demand surged for high-quality yields, especially amid persistent economic uncertainty and tight stock market valuations. This robust demand was reflected in continued strong inflows into both ETFs and actively managed funds, especially at shorter and intermediate maturities, though the overall pace of inflows moderated relative to the record-setting trends earlier in the year. On the economic front, softer labor data and slower earnings growth projections encouraged a “risk-off” posture, with institutional investors—particularly insurance companies and pensions—favoring investment-grade corporates to match long-term liabilities and capture yields near their highest since 2010. Meanwhile, the Federal Reserve’s steady policy stance and signals of possible rate cuts in the second half of the year amplified investor appetite for yield without taking on additional credit or duration risk. Supply conditions remained robust, with new issuance for the year running ahead of 2024’s strong pace, though net new supply was limited by heavy redemptions. Foreign investor purchases also provided steady support, partly offsetting the variability in domestic fund flows.
Figure 5: U.S. Investment Grade Corporates have moved slightly higher on a relative basis. Given the long-term downtrend in place, we are monitoring closely for signs of a breakout or a reversal back into the relative downtrend.
U.S. High Yield: The composite model declined into August due to an indicator calling small-cap stocks turning negative. High-yield bond breadth has also deteriorated. However, spreads are still relatively tight and longer-term trend indicators are holding up. We are moving to a neutral allocation.
Commentary: Despite slower U.S. economic growth indicators—such as subdued housing starts and ongoing tariff uncertainties—investors remained attracted to the high yield space due to its appealing income profile amid relatively stable credit fundamentals. Inflation showed moderation, which bolstered expectations that the Federal Reserve might begin cutting rates starting in September, supporting bond prices. New issuance rebounded strongly in June and continued into July, with monthly volumes reaching their highest levels since 2021, driven primarily by higher-quality, senior-secured bonds. This reflected issuers’ attempts to lock in favorable financing amid uncertain growth prospects. Credit spreads remained roughly stable year-to-date, staying near tight levels seen prior to the tariff shock in April, with B-rated bonds outperforming lower-rated segments. Sector performance was mixed, with Consumer Products, Energy, and Retail leading the gains, while Gaming, Leisure, and Insurance lagged behind. Investor flows into high-yield funds were robust, with significant inflows supporting liquidity and demand. Treasury yields continued to decline modestly, which helped boost total returns. Overall, the high-yield market balanced cautious optimism about growth and Fed accommodation against risks from trade policy and corporate credit quality, maintaining an attractive yield of nearly 7% with tight spreads of just under 3% in July.
Figure 6: Weakness in small-cap stocks is negative for high-yield bonds.
International IG Bonds: The composite model declined into August with bearish indications from relative option-adjusted spreads and credit default swaps. Higher U.S. equity risk, as described by the increase in the VIX, somewhat offsets the negative message. We are reducing exposure to neutral.
Commentary: Despite global growth concerns and lingering geopolitical uncertainties, credit spreads for international IG bonds tightened further, signaling improved investor confidence and risk appetite. This tightening was partly driven by easing tariff tensions, which had earlier triggered market volatility, as well as ongoing stabilizing fiscal policies in major economies, including the European Union. Central banks played a significant role in the backdrop: the European Central Bank (ECB) maintained a cautiously accommodative stance, with expectations of gradual rate adjustments that kept sovereign yields relatively anchored. Meanwhile, the U.S. Federal Reserve’s maintenance of steady policy rates indirectly influenced global IG bonds by shaping cross-border capital flows and exchange rates. On the supply and demand side, new issuance was robust but absorbed by the market, supported by strong demand from institutional investors and foreign buyers. Fund inflows into global IG bond ETFs showed resilience, reflecting a search for yield in a low-growth, rate-uncertain environment. Sector performance was mixed, with financials leading returns, while industrials and healthcare lagged amid sector-specific headwinds.
Figure 7: International IG Corporate trends are indicating a negative short-term reversal.
Emerging Market Bonds: The EM bond model remains bullish. Trend, relative strength, and EM equity momentum are bullish supports. The lone negative is the strength of the U.S. dollar over the past month. We remain overweight, but we are reducing our exposure until we see the dollar lose strength.
Commentary: Despite lingering uncertainties from U.S. trade tariffs initiated earlier in the year and geopolitical tensions—such as escalations in the Middle East and South Asia—investors showed renewed confidence. The JPMorgan EMBI Global Diversified Index reflected a steady appetite for EM hard currency debt and compressed sovereign spreads. Monetary policy divergences played a key role. Many EM central banks cut rates to support growth, contrasting with the U.S. Federal Reserve’s steady “higher for longer” stance. Auction activity revealed cautious but solid demand, with high bid-to-cover ratios supporting issuance despite supply pressures. ETF flows into EM bonds turned positive after earlier recent outflows, signaling growing investor confidence, particularly in higher-yielding sovereign and quasi-sovereign securities. Sector and maturity spread movements were mixed: shorter maturities remained stable, while spreads on some newer issuers widened, reflecting selective risk. Overall, the EM bond market in July balanced positive external drivers and cautious risk premiums, offering investors both yield and growth exposure amid global uncertainty.
Figure 8: Emerging Market equity momentum has supported EM bond prices. A decline below the 0 line would lead us to reduce exposure.
Catastrophic Stop Model
The Catastrophic Stop model combines time-tested, objective indicators designed to identify high-risk periods for equities and assets with high correlations to the equity market. The model entered August recommending a fully invested allocation relative to the benchmark for credit sectors with high correlations.
The Day Hagan Catastrophic Stop Model currently stands at 72.7%, indicating investors should maintain their benchmark exposure. Technical indicators are mixed, with longer-term trend signals still bullish but short-term indicators showing overbought conditions. Sentiment is extremely optimistic, yet institutional positioning remains neutral. The model suggests a likely short-term consolidation phase before the market potentially resumes its upward trend. Should conditions continue to deteriorate, the model is poised to objectively signal a reduction in equity exposure.
Figure 9: The Catastrophic Stop model recommends a fully invested position (relative to the benchmark). Note: Due to the use of indices to extend model history, the model is considered hypothetical.
The Day Hagan Daily Market Sentiment Composite remains in the excessive optimism zone. With sentiment indicators, we go with the flow until it reaches an extreme and reverses. In other words, we will rate this indicator as neutral until it reverses back below 70.
Figure 10: S&P 500 Index vs. Day Hagan Daily Market Sentiment Composite.
Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. Currently, the uptrend remains intact. The broader-based composite models calling U.S. economic growth, international economic growth, inflation trends, liquidity, and equity demand remain constructive. The Catastrophic Stop model is positive, and we are aligned with the message. If our models shift to bearish levels, we will raise cash.
This strategy utilizes measures of price, valuation, economic trends, monetary liquidity, and market sentiment to make objective, rational, and unemotional decisions about how much capital to place at risk and where to allocate that capital.
For more information, please contact us at:
Day Hagan Asset Management
1000 S. Tamiami Trl
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Symbol: SSFI
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