We retain a modest tactical duration overweight between the 3-5Y tenors on the Treasury curve. At these levels, we believe that market pricing is substantially above fair value. Market positioning is also unusually short, creating scope for a reversal if incoming data challenge the prevailing bearish view.
Underlying inflation offers some encouragement. Wage pressures are subdued, market-based services inflation is stabilising, and the annual impact of tariffs should gradually fade, as base effects from the initial impact are now in rolling one-year prices. Following the more hawkish Jackson Hole communication, a hike is our central expectation. However, we see less reason for tightening substantially beyond the path already discounted. A hike will primarily serve to shore up the Fed’s credibility rather than as a tool to severely tighten financial conditions.
This remains a tactical position. Growth and employment are resilient, yields retain upward momentum, and fiscal deficits and heavy global issuance weigh on the long end. Attractive valuations on the long end alone cannot trigger a rally. Treasury buybacks may ease specific pressures, but a durable improvement still requires more convincing evidence on inflation, growth or fiscal policy. Even a softer inflation release will likely support the front end more reliably than longer maturities, where term-premium concerns remain important. The sell-off so far has to a remarkable degree been driven by real rates rather than inflation expectations, so upsets to the strong growth picture are probably the likeliest channel to trigger a recovery.
We keep our duration overweight centred on the 10Y Bund. Yields approaching 3.5%[1] suggest attractive fair value. Large speculative shorts and improving supply dynamics in the fourth quarter also support the position. With markets discounting three ECB hikes by April 2027, a substantial amount of tightening is already reflected in prices. The 10Y Bund level therefore not only fully prices an aggressive hiking cycle but also embeds a significant term premium that implies continued resilient growth.
In terms of inflation, low gas inventories could translate into price spikes if they become critical. We expect the September ECB hike and acknowledge scope for further tightening. Core inflation is more contained than headline inflation, but second-round effects warrant close monitoring. However, any spikes in inflation driven by energy will no doubt also have knock-on effects for growth. Current market pricing appears to reflect a narrow scenario in which inflation is high and sticky enough to push the ECB to tighten aggressively, while also avoiding a downside shock to growth.
We maintain our ten-to-thirty-year steepening bias, reflecting structural changes in long-end demand and prospective German issuance. France and Belgium remain underweights. We prefer selected Central European sovereigns, including Slovakia, Slovenia and Bulgaria, where more manageable debt burdens and attractive spreads support relative value. We also like select sub-sovereigns which can offer yield pickup for a risk profile that is not materially lower than associated sovereigns.
We increase our Australian duration overweight and initiate an underweight in New Zealand. Australia has already delivered 75 basis points of tightening this year, with another hike priced.[2] Its large variable-rate mortgage market should transmit restrictive policy relatively quickly to household spending, and indeed some cooling in the housing market has already become apparent.
New Zealand is an economy that has been running ahead of Australia in several developments and now presents a different picture: policy has become accommodative again, activity is beginning to recover and inflation is prompting normalisation. Yield spreads between the two markets stand near historical extremes. We expect convergence as Australian restraint takes effect while NZ inflation – which peaked earlier than Australia – is now following the same path, edging upwards again.
We remain moderately positive on hard currency sovereigns, local debt and EM corporates. Sustained inflows and supportive technicals underpin the stance, while attractive all-in yields continue to draw investors. Fundamentals are more mixed, with commodity exporters benefiting from stronger terms of trade and importers facing pressure.
Valuation limits our enthusiasm. Sovereign and corporate spreads are close to their tightest levels since 2007.[3] Relative value remains more compelling in selected high-yield sovereigns than in EM investment grade or corporates. Local markets still offer opportunities among higher yielders, although real-rate advantages over the US have narrowed.
We retain our positive view on the yen after its sharp appreciation. Intervention helped initiate the move, but the case now has broader support from monetary policy, potential domestic investment flows and improving market positioning. These developments offer a more persuasive basis for sustained strength than intervention alone.
The Government Pension Investment Fund (GPIF) is central to this. Its benchmark allocation is broadly divided equally between domestic bonds, foreign bonds, domestic equities and foreign equities. Higher Japanese bond yields now make domestic assets more competitive.
A shift towards Japanese assets could generate substantial yen demand. It could also encourage other domestic investors to reconsider overseas allocations. However, the prospective GPIF reallocation remains a possibility, not a confirmed decision. We regard it as a potential catalyst and avoid assuming either its timing or its size.
BoJ communication increasingly points towards faster tightening. The markets now discount roughly 90 basis points of hikes over the coming year,[4] compared with around 70 basis points a month earlier. A firmer response to inflation would help narrow the policy divergence that has weighed on the currency.
Positioning and technical signals reinforce the view. Investors are retreating from using the yen as a “free” funding currency for which uncovered interest rate parity does not seem to hold. The yen also offers a potentially stronger diversifier for equity risk as the dollar's defensive correlation weakens. We nevertheless remain below maximum conviction after the rapid move, recognising scope for consolidation.
Elsewhere, we take profits on BRL and MXN and return both to neutral. EM FX positioning has become crowded, while BRL carry relative to volatility is less attractive ahead of the elections. We retain INR and IDR longs.
We reduce credit risk as heavy autumn supply meets tight spreads and softer flows. We reduce but retain our positive conviction on EUR non-financial IG credit, while US investment grade returns to neutral. We retain a more positive grade on EUR financial credit. We turn negative on EUR high yield and even more cautious on US high yield. The investment-grade adjustment is mainly tactical based on technicals, while our high-yield concerns increasingly extend to weaker borrowers' ability to refinance.
The scale of technology financing is changing the market. Hyperscalers, data centres and semiconductor companies have issued around $250 billion this year,[5] with additional technology supply expected before year-end. This is unprecedented issuance for a sector that has thus far been able to rely largely on internal cash generation for its financing needs.
Demand continues to absorb these bonds, but increasingly on more demanding terms. Technology IG spreads, which historically traded below the broader market because of stronger ratings, now trade above it – despite still holding a stronger average rating.
Alphabet illustrates the change. Its August five-year issue offered an estimated new-issue concession of 18 basis points, against 10 basis points for the comparable February transaction, with the same AA composite rating. While by no means a massive deterioration,[6] this shows that even highly rated borrowers must pay for the volume of their financing needs.
Higher government yields also compete for allocations, just as record credit issuance competes with sovereigns. This overall increase in supply coming from all sides can challenge credit performance even when fundamentals remain solid, which explains our decision to reduce exposure tactically while retaining select convictions.
The initial pressure is largely technical, but it creates a sharper focus on fundamentals. Hyperscalers earnings remain strong, while free cash flow weakens as capital expenditure accelerates. That distinction matters to bondholders: debt service depends on cash generation, not net income. Ratings remain robust, yet investors increasingly question how investment commitments translate into future cash flows and leverage.
We have therefore become more selective on technology exposure. Higher spreads can create opportunities, but the premium needs to provide an adequate buffer against weakening fundamentals.
We keep our positive view on EUR financial IG and AT1s. Bank profitability and capitalisation remain solid, while issuance is comparatively contained. The broader investment-grade backdrop also remains resilient, with positive rating trends and companies managing costs effectively. EUR IG yields around 4.0%[7] continue to offer meaningful income. Our reduced conviction reflects the near-term balance between supply, demand and valuation rather than a broad deterioration in credit quality.
High yield spreads provide limited compensation for growing dispersion. Lower-rated borrowers face expensive refinancing just as access to alternative funding becomes less dependable. In the US, default activity is rising and recoveries are weakening, even while stronger issuers continue to meet their obligations. Tight spreads obscure these differences. In AI-related high yield, notably data centres, spread widening already contrasts with the resilience of the wider market. We favour balance sheet resilience and remain cautious on businesses facing disruption or heavy investment needs.
[1] Source: Bloomberg©, 14 September 2026
[2] Source: Bloomberg©, 14 September 2026
[3] Source: Bloomberg©, 14 September 2026
[4] Source: Bloomberg©, 14 September 2026
[5] Source: Bloomberg©, 14 September 2026
[6] Source: Bloomberg©, 14 September 2026
[7] Source: Bloomberg©, 14 September 2026
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