Financial Rebellion

Market pressure is triggering some positive effects too. Central banks are behind the curve but have started hiking. Over time, higher front-end rates are likely to restore credibility. US inflation has stayed above target for the longest period in recent history (Chart 6), and long-end bonds have deviated from policy rates as a result (Chart 7). As the global hiking cycle gains momentum, support for long bonds is likely to increase. Inflation breakevens have remained steady over the past few months, suggesting that any normalisation in commodity prices is likely to compress real yields.

One risk to global rates relates to growth. If the AI boom is real, productivity and returns on capital can sustain higher rates for longer. The outlook for technological developments is hard to call, but tech valuations already imply 15% earnings growth. Historically, the gap between capex and GDP growth has been mean-reverting, and 2026 will mark the five-year high. With AI investment accounting for 20–50% of US growth in 2025, forecasts can move quickly. US rate-sensitive consumption and investment remain substantial despite the rise of AI.

A regime change from a hawkish to a dovish narrative does not take long to materialise. As recently as September 2025, markets were pricing five Fed cuts for 2026. Reality turned out quite differently. With Fed pricing having recently turned strongly hawkish, and risk assets starting to feel the impact, the balance of risks is turning towards owning longs in rates.

The more worrying angle remains the fiscal story. Interest expenses are weighing on an increasing share of deficits (Chart 8), making debt harder to stabilise. The cost of refinancing US debt has doubled in 2025 alone. Historically, levels of US debt close to current levels have preceded a sustained increase in the long-term cost of debt. The US administration is acknowledging the problem, through buybacks and verbal intervention, but more political cohesion is needed for a proper fix. The global trend points in the same direction, at least in G10 markets.

Painful moves in interest rates and widening real yields mean some long-term value is being created. We see value in belly and long-dated tenors of selected yield curves, e.g. US and Germany. The front-end is sensitive to the repricing of hikes but a high starting point means bonds with 4-5 years duration only lose 30% of carry for every 50bp of re-pricing. The long-end can even benefit, as central banks re-gain credibility.

Value in yields translate into value of rates-sensitive assets, such as investment grade credit. A 6% yield on US investment grade credit belongs to the right tail of the historical distribution and has been followed by one-year returns in the 3–13% range. Within IG credit, spreads appear elevated relative to fundamentals, creating opportunities in long-dated senior bank debt, selected hyperscalers and high-quality hard- and local-currency emerging-market debt.

Credit spreads are less attractive. Losses in fixed income have been driven by rates, with spreads below the 10th percentile of the historical distribution in high yield markets. The road to rates normalisation goes through economic softness, which does not bode well for credit risk. The recent increase in rates volatility provides a catalyst for wider credit spreads. We maintain a cautious approach to higher-yielding credit, keeping exposure low and limiting it to well-anchored issuers. We favour defensive sectors, such as financials and telecoms, and avoid cyclical areas, emerging market high yield credit and European periphery spreads, including Italy.