U.S. taxable investment-grade bonds posted a roughly break-even result in the first quarter, as measured by the Bloomberg U.S. Aggregate Bond Index. A positive start to the year was upended in March by a sudden rise in geopolitical risk, which pushed U.S. Treasury yields higher and bond prices lower.

As 2026 began, the U.S. bond market was coming off a strong 2025 in which the index rose 7.30%, its best annual result since 2020. That advance was aided by relatively stable inflation and a largely resilient U.S. economy, conditions that by the second half of the year prompted the U.S. Federal Reserve to resume the monetary-easing program it had paused in late 2024. The Fed cut its policy interest rate by a quarter percentage point (25 basis points) in September, October and December.

Following its December 2025 committee meeting, Fed officials signaled they might hold rates steady for a time. With inflation stable but still above the 2% target, and labor-market data softening even as unemployment remained low, Fed Chair Jerome Powell indicated a wait-and-see stance. This announcement shifted the market's expectation for additional rate cuts to later in 2026. In the absence of an immediate catalyst, U.S. Treasury yields were little changed in January, limiting price volatility. The Aggregate index advanced slightly for the month (+0.11%).

February brought a catalyst in the form of U.S. inflation and employment data. Headline inflation for January came in at 2.4%, the lowest reading since May 2025, while the jobs report showed solid January hiring. The annual benchmark revision to payroll data, however, adjusted total job gains for 2025 sharply down. Together, these reports were viewed as potentially accelerating the Fed's timetable for further rate reductions. At the same time, broad-market investors adopted a more defensive posture. These factors fueled a bond market rally in February, lifting the index by 1.64%. The market landscape changed abruptly at the end of February. In the late hours of February 28, the U.S. and Israel launched military operations against Iran. Tensions between the countries had been building in prior weeks but had not materially affected markets until then. The beginning of March saw a sharp rise in bond yields as expectations for Fed cuts shifted outward once again, and an increased risk premium was priced into the yield curve. Oil and energy prices surged, heightening investor concerns about a potential spike in inflation. The benchmark 10-year U.S. Treasury began the month at 3.97% and ended at 4.30%, after peaking at 4.44% on March 27. The index returned -1.76% for the month, reversing February's upturn.

Against a backdrop of rising yields, short-term debt issues with maturities of 1 to 3 years fared best in Q1, advancing 0.32%. Bonds with maturities of 3 to 5 years eked out a small gain (+0.04%), while all longer-term categories finished in modestly negative territory. Amid a cautious market backdrop, higher-quality bonds rated AAA and AA outperformed investment-grade debt rated A and BBB.

At the sector level, U.S. Treasurys (-0.04%) outpaced more credit-sensitive U.S. investment-grade corporate bonds (-0.54%). Securitized sectors – including agency mortgage-backed securities (+0.40%), commercial mortgage-backed securities (+0.32%) and asset-backed securities (+0.31%) – outperformed, as investors viewed them as offering higher income and solid fundamentals.

Outside the Aggregate index, U.S. Treasury Inflation-Protected Securities gained 0.26%, per Bloomberg, while U.S. high-yield corporate bonds (-0.50%) and emerging-markets debt – both investment-grade (-1.32%) and high-yield (-1.40%) – lagged amid risk-off market sentiment. ■

As 2026 began, it appeared that markets were firing on all cylinders, with investors expecting AI-fueled capital spending and fiscal support from the One Big Beautiful Bill Act to provide a supportive backdrop. But markets took a pause in Q1, as concerns over the viability of AI investment started to surface, and global equity and bond markets sold off sharply as geopolitical events in Iran took center stage.

Developed-market central banks were largely in sync over the past two years, easing monetary policy from restrictive levels as inflation fell from pandemic peaks. Heading into the year, the U.S. Federal Reserve was expected to cut rates further in 2026, but rising oil prices have fueled inflation fears, shifting expectations away from cuts and toward the possibility (but not necessarily likelihood) of rate hikes this year.

After falling in 2025, nominal 10-year U.S. Treasury yields finished Q1 slightly higher. At quarter end, crosscurrents influencing fixed-income yields include softer labor-market data, higher near-term inflation expectations, a shift in monetary policy expectations and medium-term fiscal challenges. Versus the Aggregate index, the ETF was overweight risk assets as of March 31, with a tilt toward short- and intermediate-term investment-grade corporate credit, high-yield securities, leveraged loans and international credit. It also was overweight U.S. Treasurys, including nominal securities and futures, as well as asset-backed securities and commercial mortgage-backed securities. The fund had below-index exposure to government-agency mortgage-backed securities and long-dated investment-grade credit. At quarter end, the portfolio maintained a duration moderately longer than that of the index.

In a dynamic environment, we continue to find pockets of value within the fixed-income market, based on our view of pricing and fundamentals. Our goal remains to work with our investment teams to try to find attractively priced bonds for the portfolio while maintaining a disciplined approach to risk management.

It is important to reiterate that the portfolio is constructed with a careful emphasis on security selection, especially with consideration to liquidity and financial resiliency. Investing is a long-term endeavor, and we're focused on generating strong risk-adjusted performance over a full market cycle. Given this focus, our long-term performance remains compelling. ■