Higher bond yields, better income: where fixed income offers value

What’s driving higher bond yields?

Global bond markets have undergone a sharp repricing, with long-term government yields reaching levels not seen since before the 2008 Global Financial Crisis. Three forces are driving yields upwards: rising energy prices following the closure of the Strait of Hormuz, renewed policy tightening by major central banks and growing fiscal deficits that have increased government borrowing needs. Bond supply has also become an increasingly important market driver. Sovereign issuance is rising just as private-sector borrowing remains strong, including AI-related investment by hyperscalers that is increasing competition for capital.

The rise in yields has been led not by inflation expectations, but by higher real yields and term premia (Figure 1). Investors are demanding greater compensation for holding long-dated debt amid fiscal uncertainty and elevated issuance.

Importantly, markets are already pricing a meaningful amount of future tightening. Investors expect several additional Fed rate increases through 2027 and further policy tightening from the ECB. In other words, much of the expected central-bank response is already reflected in current bond yields. For yields to move significantly higher from current levels, policymakers would likely need to tighten far more aggressively than investors currently expect.

FIG 1. 10-year Treasury yield: real yield, inflation compensation and the rising term premium, 2016-2026 

Plus ça change? Not this time

We do not believe today's environment resembles the inflation shock that triggered the aggressive tightening cycle of 2022-2023.

Growth remains resilient, but labour markets are more balanced and underlying inflation pressures are considerably weaker. Corporate earnings remain robust, defaults are contained and productivity growth is helping offset wage pressures.

Read also: The outlook for bonds: why this is not 2022 all over again

While headline inflation has risen, the increase is largely energy-driven. Wage growth remains subdued, reducing the risk of a wage-price spiral. Policy rates are also far closer to neutral levels than they were in 2022, suggesting central banks are more likely to fine-tune policy than embark on another prolonged tightening cycle.

Higher market interest rates are already tightening financial conditions. Real yields near 3% and mortgage rates above 7% should help moderate demand without requiring substantially higher policy rates.

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Global Fixed Income Opportunities

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Income is back 

The recent sell-off has significantly improved the attractiveness of fixed income. Today's higher starting yields allow investors to lock in income levels that were unavailable for much of the past decade, providing an important cushion for returns.

We see the strongest opportunities in high-yield bonds and emerging-market corporate debt, where higher yields offer attractive compensation for risk. Given uncertainty around the precise peak in yields, we favour building exposure gradually rather than attempting to time markets.

Our approach focuses on diversified duration exposure; adding fixed-income exposure gradually as yields become more attractive; and selective credit opportunities. A more benign inflation backdrop, limited monetary tightening or easing geopolitical tensions could support bond returns, while renewed energy shocks, fiscal concerns or heavy issuance could keep yields elevated.

Read also: Emerging Value Bond navigates volatile EM credit markets in its first year

France: the key sovereign risk to watch

France remains the key sovereign risk to watch. French government bond spreads versus Germany have widened to levels last seen during the eurozone sovereign debt crisis, and French 10-year yields have recently risen above those of Greece.

While fiscal concerns about France are justified, we believe comparisons with Greece’s crisis are misplaced. France faces a fiscal adjustment challenge rather than a systemic crisis. Strong household savings, a broadly balanced external position, uninterrupted market access and continuing economic growth distinguish it from Greece (Figure 2).

FIG 2. Greece in 2009 and France in 2026: public debt, budget balance, primary balance, current account and national savings (% of GDP) 

For investors, two questions matter. The first is whether French bonds should be held below benchmark weight. Given France's substantial representation in sovereign bond indices and the additional yield now available, maintaining a persistent underweight position carries risks.

The second is whether there is tactical value in increasing exposure. While long-term value is improving, political uncertainty surrounding the budget process and the 2027 presidential election could generate further volatility. 

We prefer to remain close to benchmark weight for now. We believe the ECB would intervene only if stress spread beyond France and threatened broader eurozone fragmentation. Until then, fiscal policy remains the primary mechanism for restoring market confidence.

Read also: Good growth, bad rates? When higher bond yields take centre stage

Making higher yields work harder

Despite recent volatility, our outlook remains constructive. Higher yields have restored value across fixed income and created attractive entry points for long-term investors. We favour a diversified approach across duration, credit and equity risk, while adding bond exposure gradually and selectively.

In sovereign markets, France warrants careful monitoring but does not currently resemble a Greece-style crisis, in our view. Our preference is to stay neutral until greater clarity emerges around the budget process.

Overall, income is once again a meaningful driver of returns. In an environment where much of the anticipated policy tightening is already priced in, we believe investors do not need to call the exact peak in yields to build fixed-income exposure.

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