When you visit our website, information may be stored or recovered on your device, mainly in the form of cookies. We use essential cookies to ensure the website works as it should, and statistical and marketing cookies for audience measurement and content customisation purposes. We rely on Google to store your consent choices and manage the activation of cookies accordingly. For more information on this, please also refer to the Google policy on Business Data Responsibility.
From the Cookie Management Centre, you can set your preferences with respect to the use of cookies: accept or reject certain categories, accept all, or reject all. For detailed information on all cookies used across these three categories, please refer to our Cookie Policy.
Please note that blocking certain cookies may affect your experience and the services offered.
Essential cookies Always active
Essential cookies help the website to work as it should by enabling necessary functionalities, such as navigating between pages and accessing secure areas. These cannot be disabled in our systems.
Statistical cookies
Statistical cookies help us understand how visitors interact with our site by collecting and communicating browsing information. They make it possible to identify the most and least visited pages and to improve the overall performance of the site.
Marketing cookies
Marketing cookies are used to display relevant advertising and measure the performance of campaigns. If you choose not to allow these cookies, you will continue to see ads, but they will be less relevant to your interests.
Choose the purposes for which we may use Google products to collect and use your data:
User storage: to technically permit advertising functionality.
User data for advertising: to optimise our advertising campaigns.
Ad customisation: to tailor advertising to your interests.
The outlook for bonds: why this is not 2022 all over again
Sandro Croce
CIO, Fixed Income
Philipp Burckhardt, CFA
Fixed Income Strategist and Senior Portfolio Manager
key takeaways.
Central banks are raising policy rates, but this is not déjà vu for fixed income: we expect less of a hiking cycle and more an ongoing recalibration
While inflation-driven volatility is likely to be a recurrent feature of bond markets, attractive all-in yields offer opportunities
We are positioned close to the benchmark while preserving our constructive stance, tilting our portfolios towards spaces opportunities like duration and emerging-market debt.
The rise in the benchmark Federal Open Market Committee (FOMC) policy target range to 3.75-4.00% announced after the Federal Reserve’s (Fed’s) September meeting came as no surprise; markets are already pricing in a further one-to-two hikes before the end of the year, and three in total by mid-2027. But what does this initial 25 basis-point (bp) hike mean for bond markets?
The Fed’s move comes amid strong growth, higher than expected inflation and ongoing volatility driven by conflict in the Middle East, as well as high fiscal deficits in the US and other major economies. Does it signal the start of a new hiking cycle that fundamentally changes the outlook for bonds, or could this turn out to be more of a recalibration that helps discerning investors unlock value?
The same but different: why it isn’t déjà vu for fixed income markets
As we write, 10-year Treasury yields are hovering above 5% – surpassing highs reached in October 2023 and heading for levels not seen since 2007. However, a key element of the current environment is very different from the situation at the beginning of the last hiking cycle: rather than being at zero, policy rates are starting from a level reflecting growth-plus-inflation.
Between March 2022 and July 2023, the Fed raised its policy rate 11 times from a target range of 0-0.25% to 5.25-5.50%. Today the policy rate is much closer to what can reasonably be considered to be a neutral level. From this position, far less tightening should be needed to have the desired impact.
Further, in 2022 the macroeconomic environment was characterised by a tight US labour market, provoking fears of second-round effects. This time around, evidence suggests the labour market has normalised.
Inflation is rising, but rather than true overheating, this is more of a supply shock. Oil prices are up again, refuelling short-term inflation and putting pressure on the short end of the yield curve due to expectations of a greater response by central banks. AI-related investment is also potentially inflationary in the short term, given bottlenecks in the hardware supply chain and high demand for specialised labour for construction, as well as the impact of data-centre energy consumption on electricity prices. However, AI implementation should eventually drive productivity gains, creating deflationary pressure — we note that Fed Governor Kevin Warsh is a strong advocate of the idea that we are entering a high-productivity environment as a result of AI.
sign up for our monthly newsletter.
Thank you for subscribing to our monthly newsletter!
There was an error registering your subscription. Please email loim-digital@lombardodier.com.
By looking at US Treasury Inflation-Protected Securities (TIPS), it is possible to identify the proportion of yields coming from inflation compensation. Markets are pricing inflation at about 2.35% per year over the next 10 years – so not particularly high. Our view is that the material repricing of real yields is instead driven by other factors. These include: strong growth, the need for higher monetary policy, and competition between governments (who need to service their deficits) and large corporates (who want to fund AI investment), in combination with uncertain political and economic trajectories.
Another differentiating factor potentially pushing up yields is that the marginal buyer has changed. Four years ago, central banks were carrying out huge quantitative easing (QE) programmes, buying sovereign bonds regardless of price. Today, competitive buyers who are able to pick and choose between assets are calling the shots.
Finally, the relationship of sovereign yields to policy rates is very different from the situation during the last hiking cycle. In 2023, two-year German bond yields peaked at just over 3.30%, while the European Central Bank (ECB) policy rate stood at 4.00%. As the time of writing, the market is pricing a top for ECB rates of 3.50%. German two-year yields are already at 3.30%, while at 3.35%, German five-year yields have easily surpassed their 2023 peak of 2.90%.
FIG 1. Then and now: comparing trough-to-peak US and German sovereign yields during the last hiking cycle with current levels1
Sovereign bond
January 2022 yield
Peak yield during 2022-23 tightening cycle
September 2026 yield
Peak-to-current change in yield (bps)
US 2-Year Treasury
~0.95%
~5.22% (Oct 2023)
4.67%
-55
US 10-Year Treasury
~1.76%
~4.99% (Oct 2023)
4.95%
-4
Germany 2-Year Schatz
~-0.61%
~3.40% (late 2023)
3.20%
-20
Germany 10-Year Bund
~-0.09%
~3.03% (Oct 2023)
3.44%
+41
Fiscal deficits: not a problem – until they are
One concern being raised by investors is risk around fiscal policy and government debt. Significant measures were implemented post-COVID to boost economies back into growth; however, little has been done since then to rein in spending in anticipation of a deterioration.
In theory, fiscal policy should be countercyclical, supporting the economy through easing when it slows. Currently, the US Government’s fiscal approach is fuelling an economy which is growing strongly, to the point where the Fed is being forced to act as a counterbalance. With a deficit already standing at over 6% of GDP, the question arises: what would happen to deficits and/or fiscal policy were the economy to slow down materially, or employment rise?
Debt in itself is not a problem, as long as credibility and creditworthiness provide support; Japan has been able to live with high levels of government debt for over 20 years because it has high net savings. However, countries like the US and France have twin fiscal and current account (trade) deficits. In this context, central bank steps to limit inflation communicate an important message to give confidence to investors.
In Europe, the implications of political polarisation and rising populism for fiscal policy are a potential concern. In particular, budget discussions are likely to be difficult in France, with little desire for parties to compromise their positions ahead of next year’s presidential elections.
More important for bond-market performance than actual changes in interest rates is the market’s changing views of where they are headed. The latest flare in yields is due to a complete repricing of rate expectations.
In the Q1 2026 issue of Alphorum, we flagged the risk of the US economy proving warmer than markets had perceived to that point. In February, prior to the Middle East conflict, markets were pricing in Fed rate cuts to 3%, although the lowest they actually went was 3.5-3.75%. Markets are now pricing US rates to rise to 4.5%: that 150 bps of repricing is clearly being felt.
Similarly, at the start of the year, the European economy appeared to be slowing down, with market makers flagging the likelihood of recession. However, expectations have now flipped to an acceleration. The benchmark ECB deposit facility rate stood at 2% at the beginning of the year; markets are now pricing it to rise to 3.5% by mid-2027.
The latest flare in yields is due to a complete repricing of rate expectations
Expect less of a hiking cycle, more of a recalibration
In the past, rising rates have burst bubbles that have been able to grow in a low-rate environment – central banks are therefore unlikely to keep rates high for long if they can avoid it. We do not foresee rates going far beyond levels markets have already priced in.
Our base case for the next six months is that inflation will remain somewhat volatile due to the Middle East conflict, but growth will start to slow down. In this scenario, central banks are likely to slow and eventually halt their recalibration.
The Middle East remains the key question for the fixed income outlook
The key factor that could derail a ‘Goldilocks’ scenario of high growth and low inflation is the ongoing conflict in the Middle East. If oil prices stay high – or go even higher – and oil and gas supplies continue to be disrupted, inflation could accelerate while growth stalls.
It should also be remembered that while Governor Warsh has clearly stated that inflation is the Fed’s current priority, the bank has a dual mandate. Its responsibility to ensure full employment makes it extremely sensitive to labour market changes – a fall in non-farm payroll figures could therefore potentially force a change of tack.
We believe the heavy recent focus on rate volatility has obscured opportunities in current fixed income markets.
From a valuations perspective, all-in yields are looking their most attractive in a long time. Despite the recent repricing, yields or coupons in fixed income remain a key ingredient for future return potential, and we think they shouldn’t be ignored.
Spreads, for their part, are reasonably tight, but we believe they are reflective of the highly supportive economic backdrop. In this context the carry they offer on top of already-elevated government bond yields remains appealing, even if substantial further tightening is unlikely.
Supply has continued to surprise to the upside – particularly at US investment grade thanks to AI-related bond supply – but some widening in the secondary market has been met by healthy demand. Indeed, aside from the summer pause, fixed income has seen strong inflows year-to-date, and we continue to expect solid technicals into the last quarter.
In this supportive but volatile environment, we are positioned close to the benchmark while preserving our constructive stance, and like to tilt our portfolios into spaces where we see opportunities. As such, we have a gentle overweight in duration as well as an overweight in emerging-market fixed income.
FIG 2. Our bond outlook for corporates and sovereigns going into Q42
We are cautious on longer-end government bond curve dynamics due to risks around debt sustainability and elevated supply expectations. We prefer the front-end to the belly of government bond curves and EUR and GBP debt over USD and JPY. An overweight in TIPS complements this, as we believe inflation compensation underprices the reflationary risks we are witnessing.
We are neutral overall on investment-grade and high-yield credit but prefer US high yield over European. Within sectors, we like European real estate, while we prefer to avoid auto and auto parts, European airlines and US non-bank financial institutions. We are selective on hyperscalers and prefer shorter-dated bonds, avoiding longer-dated securities. Finally, we continue to see value in moving lower in the capital structures of companies with solid fundamentals for the increased carry on offer.
Overall, we are moderately constructive and are happy to benefit from this benign carry environment, seeking to exploit opportunities identified through research and conviction.
subscribe to investment insights and strategy updates
We expect a broadly supportive environment for fixed income over the coming months, underpinned by attractive all-in yields and improving valuation levels. Once the recent upward adjustment in bond yields begins to stabilise, this value should become increasingly apparent to investors. While interest rate volatility is likely to remain a recurring feature, some easing of geopolitical tensions, particularly through lower oil prices, could provide an additional tailwind for bond markets.
High yields by recent historical standards provide attractive entry points. They allow investors to lock in compelling income for multiple years and improve the expected risk-adjusted returns of fixed income relative to other asset classes. Tight spreads and widening credit dispersion emphasise the need for selectivity, favouring an actively-managed, selective approach over passive index-based allocations.
The nature of the current cycle is crucial. Rather than the start of a traditional and prolonged hiking cycle, we view recent central bank actions as part of an ongoing recalibration of policy settings in response to evolving economic and inflation dynamics. Markets have already repriced significantly, reducing the likelihood of further dramatic moves in yields. A gradual recalibration would be supportive for both economic activity and credit markets. However, excessive tightening could trigger a meaningful slowdown or recession, leading to wider credit spreads. In such a scenario, the negative impact from spread widening would likely be partly offset by falling government bond yields and the positive contribution from duration.
Yes. Higher real yields show that inflation adjusted returns in fixed income are rising, which we view as a sign of increased attractiveness of the asset class. At the same time, higher real yields are a burden on the cost of capital, and will impact companies and thus both equity and corporate bond markets. This impact will not be felt uniformly amongst sectors; hence selectivity is essential. However, so far, we see higher yields coming from strong growth and productivity, creating potentially compelling entry points and income opportunities – but careful credit analysis and a selective approach are essential.
Higher inflation will likely trigger a more forceful response from central banks and put upward pressure across the yield curve. This may keep government bond markets under pressure until policy rates reach sufficiently restrictive levels to slow economic activity and bring inflation back under control, potentially at the cost of a recession. The impact of higher fiscal deficits is most likely to be felt through a higher term premium and a steeper yield curve. Policymakers may seek to mitigate these pressures by adjusting the maturity profile of government debt issuance or through debt management operations. In more extreme cases, authorities could attempt to directly influence long-term borrowing costs through yield curve control, as demonstrated by the Bank of Japan between 2016 and 2024.
view sources.
+
1 FRED, CNBC, Trading Economics, as at 28 September 2026.
2 LOIM at 30 September 2026. For illustrative purposes only.
important information.
For professional investors use only
This document is a Corporate Communication for Professional Investors only and is not a marketing communication related to a fund, an investment product or investment services in your country. This document is not intended to provide investment, tax, accounting, professional or legal advice.
