The Davenport Funds Q1 2025 Fixed Income Market Update

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Q1 2025 Market Review

By traditional measures, bond investors sailed into 2025 favorably positioned to navigate evolving market conditions. Entering a new year with elevated interest rates generally bodes well for fixed income investors: they provide a “cushion” or an ability to absorb market volatility, thereby increasing the odds for long term principal stability. Against this rate backdrop, our high-quality bond bias helped deliver attractive first quarter returns. Just as important, we anticipate this emphasis on quality has and will serve as a ballast against whatever cross market currents may come our way.

Between the ceaseless barrage of market moving headlines and heightened economic data scrutiny, the quarter was largely driven by two words: inflation and growth. The intraday volatility often made days feel like weeks, the market seemingly without a clear sense of direction. Where we go from here is up for debate. One viewpoint expects inflation to remain stubbornly sticky and growth to struggle, lending credence to the newly revived term, stagflation “lite.” Another bloc sees a recession – in fact, an increasing number of Wall Street strategists and pundits seem to be endorsing this “in vogue” call.

With such fluid dynamics, taking a step back and seeing the forest for the trees seems sensible. Corporate America remains profitable and their cash is ample, which comforts us as lenders to corporations. We intentionally avoid riskier borrowers with declining cash flows and/or in challenged industries. We stick to our cooking so to say: we remain rooted in quality and exercise caution and judiciousness when considering new additions to our strategies.

On the flipside, the U.S. Treasury bond market presents a more nuanced situation. Plainly put, the runaway fiscal spending and resulting federal indebtedness concern us. Yes, DOGE and other efforts aim to streamline government operations so as to deliver material savings; however, the magnitude of such structural undertakings will take years – not quarters – to fully materialize. Tariffs are another major development that we are closely watching, due to their potential inflationary impact. With such a highly integrated global economy, we worry that most of the burden will be absorbed by the consumer, who is already low on savings yet high on debt.

Turning to monetary policy, we believe the Fed regrets its “jumbo” 50 basis point cut last year as sticky inflation lingers in 2025. Their recent Summary of Economic Projections update (i.e., the dot plot) supports the stagflation narrative with a revised upward inflation outlook and downward economic growth prognosis. At this stage, a rate hike in response to a tariff induced inflation uptick seems less likely than rate cuts prompted by a weakening labor market and/ or an accelerated economic contraction. We also believe the Fed will lean heavily on justifiable economic data before proceeding with extreme rate cuts in order to minimize reputational risk.

With an unclear outlook and a myriad of uncertainties on the horizon, we remain committed to our cautious positioning. Expensive valuations across much of the corporate bond market warrant prudence and patience – we are wary of brashly chasing for yield while disregarding the associated risks, particularly in light of the potential economic disruptions that may lay ahead. Our approach is to remain alert to changing market conditions and be open to advantageous opportunities as they arise, all while clipping coupons that are fairly priced and compensatory for the associated credit risk in the meantime.

Sincerely,

Kevin J. Hopkins Jr., CFA®, Lead Fixed Income Portfolio Manager