Ceasefire on Paper, Tension Below: Fixed Income in an Uncertain Summer

Matt Freund, CFA, Christian Brobst, and Chuck Carmody, CFA

Summary Points:

• Despite the uncertainty surrounding how much oil will flow through the Strait of Hormuz, we expect energy prices will decline through the second half of the year; inflation has likely peaked and will decline over the coming quarters.
• A new Fed chair who prioritizes price credibility, operates with deliberate opacity, and oversees structural reviews of Fed operations is likely to introduce higher rate volatility—particularly at the front end of the curve.
• Credit fundamentals remain solid; a modest uptick in leverage reflects debt issuance rather than earnings deterioration, an important distinction. Record issuance volumes across investment-grade, high-yield, and securitized markets reflect strong demand but merit monitoring as supply accumulates.

When we published our second-quarter outlook, the US–Israel strikes on Iran had just upended what had been a constructive start to the year in the markets. Three months later, energy prices have round-tripped to their pre-conflict levels despite the lack of a hard resolution to the conflict. A 60-day negotiating window is now in place, and Hormuz traffic has partially resumed. But signals coming out of the negotiations are inconsistent. Statements from Washington suggest cautious optimism; statements from Tehran range from constructive to openly skeptical of the framework's durability. At this point, tanker traffic through the Strait remains below pre-conflict levels, shipping insurance premiums remain elevated, and several conditions that produced the conflict remain unresolved. While neither side seems eager to re-engage kinetically, if the negotiating window closes without agreement, the market may need to consider whether the optimism of the last three months is justified.

Our base case remains that this chapter of the conflict is over and that energy prices will drift lower through the second half of the year. These lower prices will spread broadly through the economy, although we are mindful of other emerging inflation risks related to AI, such as memory and chip prices. As a result, inflation has likely peaked and will decline over the next several quarters. Lower energy costs will also provide relief to lower- and middle-income consumers, allowing economic growth to continue. Regardless of the outcome, we believe the domestic economy has enough momentum to avoid recession even if the conflict were to resume (though growth would shift lower).

While the economy is proving resilient and inflation appears to have peaked, the Federal Reserve may have a different agenda. At his first meeting, Chairman Warsh was explicit about the Fed restoring price stability after five consecutive years of missing its inflation target. He was equally clear that he intends to allow markets to determine prices. The practical implication is a deliberate reduction in the forward guidance. Meanwhile, task forces are examining potential changes across disciplines: communication, balance sheet management, data collection, and the Fed’s inflation framework. We view these changes as a welcome return to policies that existed prior to 2008.

This new framework has increased rate volatility (especially at the front end of the curve, where Fed guidance had the most impact). We believe the increase in rate volatility is an intentional consequence of the Fed’s new policies. The market is currently pricing one-and-a-half hikes through year-end 2026 with a terminal rate near 4%. In our view, the current leadership has little incentive to begin a tenure by shifting gears prematurely.

Credit fundamentals have held up better than the macro backdrop might suggest. High-yield defaults through May remain well below long-term averages at 2.0%. Leverage has ticked modestly higher quarter-over-quarter, but the increase reflects increased debt issuance, not deterioration in earnings. Revenue and EBITDA have exhibited solid growth while interest coverage has remained stable. Importantly, leverage is not rising because of weakening business performance.

New issuance volumes across markets have soared. Data center and digital infrastructure buildout continues at a pace that appears largely indifferent to rate levels. The knock-on effect is that investment-grade, high-yield, and securitized markets are all pacing toward record issuance years. Supply at this scale can create technical headwinds even when new issue demand is strong. We are closely monitoring the technical backdrop for any indication that the increased supply is creating greater-than-anticipated pressure on spreads.

Positioning Implications

We are maintaining our quality bias established over several quarters, as we do not expect credit beta to outperform in this environment. Spread widening has begun to improve relative value at the lower end of the credit spectrum (i.e., CCC tier), but the combination of unresolved geopolitical risk, a less predictable Fed, and record supply volumes does not yet present a compelling case for adding risk aggressively. We will selectively add credit exposure where we believe we are being compensated for the risk.

Despite the recent flattening, we believe the long-term yield curve steepening thesis remains intact. Large fiscal deficits, elevated term premium, a Fed chair focused on price credibility over accommodation, and structurally higher front-end rate volatility all argue against a meaningful decline in longer rates. Calamos Short-Term Bond Fund remains positioned slightly long of its benchmark in an effort to take advantage of yield opportunities; Calamos Total Return Bond Fund remains short of its benchmark with the underweight concentrated in long-end exposure; and Calamos High Income Opportunities Fund is positioned short of benchmark duration.