CONTRIBUTORS
Michael Buchanan, CFA
Chief Investment Officer
Western Asset
Despite geopolitical tensions and the resultant volatility in energy markets, the global backdrop is supported by policy momentum and stable corporate fundamentals. A protracted conflict risks stagflation; however, economic and political incentives point to near-term de-escalation. In this environment, disciplined active management remains essential as we position portfolios to capitalize on selective opportunities across global credit, EM and structured sectors.
Key highlights:
- The Middle East conflict and resultant energy supply shock have spiked market volatility. Longer-term inflation expectations remain anchored for now, but rising near-term inflation expectations have tightened financial conditions via fears of central banks leaning hawkish.
- US growth remains resilient as the region is energy-independent while deregulation, tax refunds and policy support are also supportive.
- Europe and the UK confront potential labor-market headwinds and are highly exposed to volatile energy prices, but fiscal measures in Germany may help to stabilize the outlook.
- In Asia, China’s recovery remains policy-driven amid structural challenges, while in Japan, expansionary fiscal policy will likely lead to a steeper curve.
- Credit fundamentals across IG and HY remain strong, with issuance elevated by AI-related capex, M&A activity and refinancing needs.
- Securitized sectors—select parts of MBS, CLOs and CMBS—offer relative value despite pressure in consumer and CRE pockets.
- EM continues to benefit from positive fundamentals while relative value varies between the local, corporate and sovereign markets.
- Investor sentiment has stayed constructive, supported by strong fundamentals and appealing yields despite geopolitical and commodity-driven risks.
Overview
In this quarterly report, geopolitical tensions are the defining feature of the macro outlook with energy supply shocks expected to weigh on near-term growth and inflation. Before these pressures the global economic backdrop was gradually improving as fiscal support, easier finan-cial conditions and moderating inflation were helping to strengthen the 2026 outlook. We believe the drastic shift in central bank policy expectations is somewhat overdone and that longer-term growth and inflation targets are still attainable. In the US, policy tail-winds and deregulation will likely support activity despite signs of softer labor conditions. Europe and the UK are more vulnerable to volatile energy prices and face labor-market challenges but German fiscal expansion may offer some stabilization. China’s recovery remains policy-driven while Japan’s expansionary fiscal policy will likely lead to a steeper curve there. Credit markets remain supported by strong fundamentals and healthy de-mand, with issuance elevated by AI-related capex and M&A. Select parts of structured products and emerging markets (EM) also offer attractive relative value. Despite cross-currents from geopolitics and commodities, investor sentiment remains constructive.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
Fixed-income securities involve interest rate, credit, inflation and reinvestment risks and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
Municipal income may be subject to state and local taxes. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.
Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value.
Floating-rate loans and debt securities are typically rated below investment grade and are subject to greater risk of default, which could result in loss of principal. Inflation-linked securities are subject to liquidity risk, prepayment risk, extension risk and deflation risk.
US Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the US government. The US government guarantees the principal and interest payments on US Treasuries when the securities are held to maturity. Unlike US Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the US government. Even when the US government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.
WF: 10156358