The Big Picture | Western Asset

KEY DRIVERS & RELATIVE VALUE
SECTOR THEMES
INDUSTRY THEMES

"Despite global uncertainty, we maintain a cautiously constructive outlook. Growth resilience in the US, policy-driven recovery in China and easing inflation trends across developed markets are creating selective opportunities. Supported by attractive yields and improving credit fundamentals, we continue to focus on disciplined, value-driven investing across resilient sectors as monetary and fiscal dynamics evolve."

Michael Buchanan, CFA
Chief Investment Officer

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US growth remains resilient despite labor market softening; inflation is above target but expected to ease in 2026 with policy support.
Europe and UK face trade-related headwinds, yet easing inflation and expected rate cuts provide a constructive backdrop.
China's recovery is driven by policy and exports, though structural challenges persist; Japan is likely to hike rates further amid persistent inflation.
Canada and Australia benefit from easing domestic cost pressures and flexible central bank stances, supporting improved growth outlooks.
Investment-grade and high-yield credit fundamentals remain strong globally, with robust demand and selective opportunities in banks, telecom and energy.
Securitized credit, including MBS and CLOs, continues to offer attractive yields, though consumer ABS faces headwinds from student loan resumption and labor softness.
We favor global banks, copper-focused metals, energy midstream and transportation, while remaining cautious on retail, utilities and lower-quality consumer credit.
Investor sentiment has rebounded, supported by attractive yields and improving fundamentals, despite ongoing macro and policy uncertainty.

OVERVIEW

Against a backdrop of global uncertainty, Western Asset maintains a cautiously constructive outlook. US growth remains resilient despite labor market softening and inflation above target, with policy tailwinds expected to support a return to trend in 2026. Europe and the UK face trade-related headwinds, but easing inflation and expected rate cuts offer support. China's recovery is policy-driven, though structural challenges persist, while Japan's inflation points to further rate hikes. Canada and Australia benefit from easing domestic cost pressures and flexible central bank stances. Investor sentiment has rebounded, supported by attractive yields and improving credit fundamentals. The US yield curve steepening reflects rising term premiums amid substantial Treasury issuance and fiscal concerns. Despite crosscurrents, Western Asset continues to identify compelling opportunities across resilient sectors, maintaining a disciplined, value-driven approach.

"As global economies navigate divergent trajectories, with resilience in the US, policy-driven recovery in China and easing pressures in Europe, our regional positioning is guided by both caution and conviction. We are strategically focusing on markets where strong fundamentals, evolving policy environments and valuation dynamics converge to present the most compelling relative value opportunities."

Mark S. Lindbloom
Deputy CIO & Head of Broad Market Portfolios

KEY DRIVERS AND RELATIVE VALUE BY REGION

Labor Market Weakening but Policy Tailwinds Expected in 2026

The Federal Reserve (Fed) and investors are focused on the weakening labor market and its impact on growth. We believe subtrend growth in 2025 is the likely outcome with reasons for optimism as we enter 2026. Fiscal and monetary policies should boost growth toward trend in 2026. With inflation still above the Fed's 2% target we are holding duration near neutral in broad market portfolios with a steepening bias. We have reduced select spread sectors given rich valuations.

EUROPE

Continent May Face Labor Market and Trade-Related Headwinds

We remain positive on growth in the eurozone, but challenges still remain. Growth in the first half of the year was boosted by frontloading demand ahead of tariff implementation. Payback is likely. The trade deal with the US has not boosted confidence, and heightened competition with China is ongoing. The labor market remains very healthy, but unemployment is rising in Germany and France. Hence we balance a modest overweight duration with a long position in the euro.

Bank of England to Cut More Than Is Currently Priced

We expect the economy to grow at a subtrend rate over the coming quarters and see risks that the labor market may loosen further. Slowing wage growth will continue to dampen inflationary pressures. With the Chancellor expected to announce tax increases in November's Budget, this tightening will act as another disinflationary force. We think that the market is discounting too little easing when we look through to 2026.

CANADA

Monetary and Fiscal Policy Supportive; Trade a Potential Pothole

The Bank of Canada cut rates in September and again this year, which will bring rates to the bottom end of neutral. Canadian business is actually relatively well placed for US trade given the USMCA, but the impact has nonetheless been large. Fiscal spending, including on defense, should help going forward. Core inflation is probably already close to target while average wage growth is declining. Renegotiation of the USMCA next year may prove to be another pothole.

AUSTRALIA

Growth and Inflation Balanced, RBA Data Dependant Going Forward

Real wage growth and Reserve Bank of Australia (RBA) rate cuts in 2025 are boosting disposable incomes (as most loans have variable rates) allowing consumers to rebuild savings and increase spending on discretionary items. House prices are rising again aided by limited supply. The RBA is now highly data dependent regarding further rate cuts, aiming to avoid creating inflationary pressures by easing policy too much.

JAPAN

Higher Rates Ahead

We expect the Bank of Japan (BoJ) to hike rates earlier than the market currently expects due to prolonged above-target inflation, a steady economy with near full employment and a negative real policy rate.

CHINA

Slow Recovery to Continue

The absence of a further escalation of tariff conflicts since the Geneva talks affirm that the US and China broadly intend to avoid full economic decoupling. China's slow recovery remains supported by policy measures and accommodative fiscal and monetary policy. Most of the resilience in 1H25 is due to front-loaded exports that were stronger than expected as well as the ongoing consumer goods trade-in program. Growth challenges will likely persist through year end.

MEXICO

Positive Developments Amid Anemic Growth

Fiscal balances have improved, but spending cuts were at the expense of infrastructure outlays, limiting medium-term growth prospects. Scheinbaum's cracking down on smuggling, tightening the border and imposing tariffs on EV imports extends an olive branch to Trump and eases tariff uncertainty for now. Supporting Pemex over the medium term via PCAP issuance is a positive development. We remain cautious on the peso and favor local rates as we expect Banxico remain dovish.

INDIA

Growth Remains Resilient Despite US Trade Pressures

India GDP growth remains resilient despite high US tariffs and inflation below 2%, and the central government is working in concert with Reserve Bank of India to deliver a supportive policy base to counter headline trade risks. On US trade, the hope is that a deal will be solidified by the end of 2025. At the same time, India will continue to nurture its geopolitical ties with other strategic partners. Indian government bonds have stabilized after the selloff in 3Q25.

BRAZIL

Continued Moderate Growth Despite Punitive Tariffs

Growth has remained resilient despite tight monetary policies, but could be challenged with higher tariffs due to the Supreme Court finding Bolsonaro guilty. President Lula's fiscal agenda is still a concern, especially ahead of the 2026 elections. If inflation continues to moderate, we expect Brazil's central bank to start cutting around mid-2026. We are modestly positive on the Brazilian real given its carry and prefer local rates in the 5- to 7-year part of the curve.

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"Emerging markets continue to offer selective opportunities as fundamentals improve and valuations tighten. We remain constructive on higher-quality sovereigns and corporates, supported by policy reforms and resilient balance sheets. While global uncertainty persists, attractive carry, IMF-backed stability and idiosyncratic credit stories reinforce our view that EM debt remains a compelling source of diversified income potential."

Prashant Chandran, CFA
Interim Head of US-Based Emerging Markets Team

WESTERN ASSET SECTOR THEMES

FUNDAMENTALS

TECHNICALS

VALUATIONS

Investment-Grade (IG) Corporate Credit

US: Earnings are resilient (Q2 revenue & EBITDA at +4%, with margins still high) but we're seeing divergence between low- and higher-end consumers (who still pay for experiences). IG is in sync with the strength of broader risk markets; however, subsector dispersion is evident with cable, aerospace and banks outperforming, while media, transportation services and consumer products lag. Technicals are healthy.

Europe: Fundamentals are resilient (especially in banking) with strong demand and financial conditions easing against a positive growth backdrop. Spreads are close to post-GFC tights thus less margin for safety. Despite some sectors (e.g., autos) facing cyclical headwinds and tariff-related uncertainty, value remains in sectors not at YTD tights. Remained biased to financials, utilities and select property companies.

Australia: IG credit remains bid, with primary markets oversubscribed and spreads tightening. Steady issuance from first-time issuers adds value. Fundamentals remain strong with leverage well contained and ratings generally on the upswing. Focus remains on shorter tenors for carry in regulated utilities, infrastructure and national champion banks, with opportunistic exposure across the capital stack.

High-Yield (HY) Corporate Credit

US: HY spreads are tight from a historical perspective but strong fundamentals and technicals (e.g., default rates are below the 25-year average and easy access to capital for refinancing), substantiate current levels. Yields above 7% justify an allocation due to healthy carry and limited excesses. Our preference remains towards cyclicals focusing on higher-quality segments.

Europe: Fundamentals continue to be positive overall. Net supply remains manageable as most bond issuance is aimed at refinancing. We continue to focus on BB/B rated issuers with a bias toward telecom/ cable, select consumer and capital goods companies. Given fairly tight valuations, we think investors can generally expect an income-type return.

Bank Loans

Leveraged loans have delivered steady, carry-driven returns this year. Floating-rate issues have lagged fixed rates due to rate cut rate expectations but lower rates going forward will be a fundamental tailwind as interest coverage rises. We favor BB/B loans with a tilt toward single-B issues for attractive carry. Amid much geopolitical and economic uncertainty, loans still offer mid-7% yields with minimal duration.

Collateralized Loan Obligations (CLOs)

CLO primary issuance remains robust and demand has remained firm. Bank loan primary issuance has picked up, which will lead to new CLO creation. Rate cuts without a recession reduce tail risks and are supportive of fundamentals. CLO AAAs remain ~10 bps wide of the year's tights. BBB/BB remain attractive. Current CLO yields adjusted for the forward curve still screen well vs. fixed-rate comps.

Mortgage and Consumer Credit

Agency MBS: Yield and spread levels are attractive relative to Treasuries and high-quality credit bonds. Despite refinancing activity resurfacing in more recently originated mortgage loans with higher rates, the bulk of US mortgage borrowers locked in sub 4.5% mortgages rates and, broadly prepayment risk remains low.

NARMBS: Cautious outlook for home prices as supply has increased meaningfully in 2025. Continued downward pressure on housing affordability has weakened borrower demand. Tariff implications have the potential to lead to home price increases given higher input costs and fewer new homes. Collateral performance measures remain positive which continue to provide strong fundamentals to residential securitized credit.

CMBS: Demand for on-the-run CMBS remains robust. AAA and senior bond spreads are fair. Further down the capital structure credit spreads are tightening as the sector continues to price wide of credit. Sufficient high-quality financing opportunities exist with 2025 new-issue volume on pace for highest annual total since the GFC. High-quality carry and total return opportunities exist for prudent credit selectors.

ABS: Consumer fundamentals are deteriorating more than expected due to resuming student loan payments and a softening labor market, affecting lower-end consumers the most. Higher inflation and fiscal policy changes are expected to have a disproportionate negative impact on lower-end consumers. We expect performance deterioration to continue across all consumer segments, so we favor higher-quality consumer credit.

Inflation-Linked

US: While real yields are elevated relative to the past two decades, they are likely to remain so with trend-like growth in the forecast. Inflation coming down outside of tariff effects is apt to keep investor interest subdued, though long-term inflation expectations are only slightly above Fed targets.

Japan: The current level of 10-year breakeven inflation at 1.55% looks cheap given the structural labor shortage and elevated inflation.

Municipals

Record municipal supply has contributed to improved income opportunities and attractive after-tax relative value versus comparable taxable fixed-income sectors. Credit fundamentals remain favorable, but are largely reflected by historically tight municipal credit spreads. We expect US growth and inflation to ebb and longer-duration and mid-grade credit components to contribute to 4Q performance.

Emerging Market (EM) Debt

Sovereigns: EM sovereigns (both IG & HY) have continued to tighten and valuations look rich. Despite continued rotation out of US assets, no visible tail event in risk markets is supportive of holding positions for now. We still favor frontier market sovereigns over IG counterparts given cheap valuations and attractive carry, with key idiosyncratic credit stories built on a fundamental turnaround and IMF support.

Local EM: Already strong YTD performance with further tailwinds (i.e., more Fed cuts to come, a gradually weakening USD, continued inflows). The tariff landscape and its impact on local inflation and trade balances must be monitored but high real yields (even as inflation has declined) leads us to favor Latin American local rates markets where central banks have room to cut if there's a global slowdown.

EM Corporates: Spreads are close to historical tights, but balance sheets and fundamentals continue to look strong. Supply broadened and strengthened with outflows turning to inflows. We remain cautiously optimistic with tight valuations prompting us to seek value in primary markets.

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"Across industries, fundamentals continue to diverge as inflation, policy and consumer dynamics reshape corporate performance. We see resilience in banks, energy and utilities, supported by strong balance sheets and disciplined capital management. Meanwhile, selective opportunities are emerging in health care and telecom as innovation and cost control offset cyclical softness in consumer-sensitive and manufacturing sectors."

Michael T. Borowske
Head of Global Credit Research

WESTERN ASSET INDUSTRY THEMES

Industry

Key Observations

Auto & Related

We favor market weight positioning in the global automotive sector in IG and HY, as the risk/reward opportunity has become more balanced over the last several months since the initial Liberation Day scare. We expect to see ongoing margin pressure for most OEMs and suppliers, which could result in more rating agency downgrades.

Banks

We maintain a large overweight position to top-quality global banks given resilient performance, as banks have lower risk profiles due to stringent regulations, heightened oversight and improved risk management following the GFC.

Energy

Domestic industry remains capital disciplined; balance sheets and liquidity are in good positions. The supply side is driving markets, particularly OPEC+ and market share agenda. Future gas fundamentals look more appealing. We are overweight natural gas producers and pipelines, but underweight oil producers, oil field service and refiners.

Food & Beverage

The environment is tougher for food and beverage firms amid higher input and labor costs. Tighter consumer budgets and declining alcohol demand create sales headwinds for premium spirits as consumers increasingly trade down. We remain underweight due to rich valuations and rising shareholder-friendly actions that limit debt reduction.

Gaming

Fundamentals in the US and Asia-based gaming markets remain sound but we are monitoring signs of consumer weakness, particularly in Las Vegas. Trips to several regions suggest that softness to date has only been felt in the lower income tiers. Outside the US, we view the long-term growth stories in both Singapore and Macau favorably.

Health Care

We remain underweight IG and equal weight HY health care. Hospital volumes are expected to remain steady relative to 2Q25 and there is increased optimism on ACA subsidies and continued approvals of Diabetes Prevention Programs. Managed care remains in an underwriting downturn; we expect cyclical margin recovery in Medicare Advantage next year.

Metals & Mining

Demand for commodities remains resilient and the market is increasingly supply driven; sustained higher prices, geopolitical and policy stability are required to incentivize project development and production. Tariffs impacts, Chinese demand, inflation, US dollar strength and interest rates influence price. We are overweight copper names.

Pharmaceuticals

We are underweight IG and market weight HY. The deadline for most favored nations pricing passed and the first deal was announced (for Pfizer). We await the outcome of the other 15 bilateral negotiations. In HY, we are focused on names with downside protection and visible credit catalysts (i.e., rising stars, liability management exercises, M&A).

Retailing

Despite macro uncertainty, spending is resilient as consumers respond to innovation, helping retailers with strategic pricing initiatives. Tariff impact has been muted so far, but we remain underweight since tariffs will create cost pressure in the second half of this year and into 2026.

Telecommunications & Media

Despite rising competition and M&A activity, we favor the largest telecom/cable issuers for their defensive traits, recurring revenue and strong free cash flow. In media, we remain selective as cord-cutting and weak ad trends pressure linear TV, forcing some companies to take strategic action.

Telecommunications & Media (European)

Telcos had a very strong quarter with competition easing in Spain and Italy while challenged, but stable, elsewhere; we are overweight due to non-cyclicality and attractive valuations, but selective to avoid M&A risk. In media, we've reduced exposure due to negative AI sentiment and contract risks. Weak auto demand keeps us underweight in tech.

Transportation

Most US airlines beat Q3 expectations, with strong corporate, premium and international demand continuing into Q4. Main cabin revenues lag, especially domestically, but improved supply/demand, stable fuel prices and a healthy macro backdrop should boost profitability and credit metrics, supporting our overweight position.

Utilities

The sector is characterized by continued higher debt issuance with industry capital budgets estimated to rise 4.5% annually through YE29. Credit quality is lower than it has been historically, and managements operate closer to downgrade thresholds. We prioritize focus on regulator support. We are underweight the sector and selectively participate.

Utilities (European)

We are overweight the sector, favoring diversified integrated and selective regulated names with manageable capex and supportive regulatory frameworks. High energy transition capex is balanced by responsible financial management (e.g., rights issues). We are cautious on pure players, especially those with US offshore wind exposure.

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