Fixed Income Forward: September 2026

We are now in an era of tighter money. The first half of September was punishing for ultra-long government bonds as yields rose to multi-year highs. The European Central Bank lifted its key interest rate by 25 basis points to 2.50% and raised its inflation forecast just as oil prices jumped again above USD 100 a barrel. Bond investors seemed unfazed by the US Treasury’s market interventions in August and September. The 10-year Treasury yield has been nearing 5% and the 30-year yield is hovering just under 5.4%.

Yet today’s yields only appear elevated when compared with suppressed levels since the 2008 global financial crisis. For many investors, the last two decades are the benchmark, but core government bond yields are below long-run averages. We may be witnessing a regime change rather than a bond market crisis – a new regime characterised by inflation risks, expanding fiscal deficits and fiercer competition for capital between government and the tech giants funding the AI infrastructure buildout.

The good news is that bonds are less overvalued than before. It is also reassuring that the end of easy money seems to have arrived in an orderly fashion. The US 10-year Treasury yield has mostly traded within a range of around 90 basis points since the start of the second Trump administration. For a market supposedly facing existential threats, that is a remarkably disciplined outcome. Of course, there is still plenty to keep us alert (see What to watch, page 3). And, importantly, this new market environment requires a different way of managing bonds than during the time of artificially suppressed rates.

For fixed income investors, a world of higher yields is not necessarily a bad thing; they are once again getting paid to own bonds. That should motivate an increase in bond allocations from a relatively low base currently. And the higher bond yields rise, the more appealing they get relative to and as a complement to equities. Traditional diversification has become harder since 2020 as in many cases bonds and stocks moved in tandem during sharp selloffs. However, the main culprits for that have been unexpected inflation flare-ups, as well as a market behaving as if 5% yields are something unusual. As the “higher-for-longer” regime gets more entrenched, we expect bonds to reassert their hedging quality.

Higher yields and the compounding income they provide can act as a cushion for equity market volatility. In a reflationary world with higher interest rates, floating rate notes issued largely by financial institutions are attractive given that the coupons they pay adjust upwards as interest rates rise. We also favour emerging market debt and Asian high yield credit, not only for their high all-in yields, but because the underlying sovereign or corporate credit fundamentals are healthy or improving – and have little reliance on the AI momentum trade.

We continue to shun big outright bets on the direction of core government bond yields, preferring to trade tactically around yield differentials across countries and maturities. For both credit and rates, we believe this environment lends itself to strategies free of geographical and sector biases. As we have highlighted, the important question is no longer where Treasury yields will be next month, but how portfolios should adapt to a world in which capital is no longer free.