In Brief
- Global government bond yields have surged to multi-year highs, but inflation, interest rate, and fiscal risks create challenges.
- Higher yield creates better entry points for core bonds, but there should be caution about extending duration.
- Investment grade credit has outperformed amid macro-driven volatility, while high yield bonds remain attractive for carry but are more exposed to growth risks and default concerns.
- Securitized assets are a good alternative, but investors should focus on quality and resilience, given the dual pressures from rising U.S. yields and a potentially stronger U.S. dollar.
The 10-year U.S. Treasury (UST) yield surged to a 16-month high of 4.66%, while the 30-year reached an 18-year high of 5.17% in May. This move to multi-year highs is not limited to the U.S.; 10-year German Bund yields rose to their highest levels since 2011, UK Gilts are at levels last seen in 2008, and Japan’s 30-year Japanese government bond yield has hit a record high. Rising yields present a challenge for investors seeking portfolio ballast against rising equities.
The recent move to higher yields, and the increase in bond market volatility, are the result of three factors.
The oil shock: Brent oil prices are 73% higher than at the start of the year, with constraints in the physical oil market becoming more apparent. Expectations for higher future oil prices are also rising; the price of Brent oil for delivery in December 2026 has increased from USD 68/bbl to USD 88/bbl since 28 February, and average oil prices are expected to remain above USD 90/bbl across this year (Exhibit 1).
The rates outlook: The second-order impact of higher oil prices, along with other key inputs flowing through the Strait, has seen the market reprice the path of monetary policy. Market-based estimates for the U.S. cash rate have shifted from 59 basis points (bps) of easing at the start of the year to 25bps of tightening by year-end. Similarly, markets are now pricing in 65bps of hikes by the European Central Bank (ECB), 48bps for the Bank of England (BoE), and 45bps for the Bank of Japan (BoJ) this year (Exhibit 2).
Fiscal concerns: Elevated levels of government debt have been a background risk for some time, reflected in a rising term premium. The prospect of further fiscal easing to offset the current economic shock has brought these concerns to the forefront and has coincided with a shift in investor allocations. Ownership of U.S. Treasuries have been in a steady decline for several years, with holdings by foreign institutions falling from 34% in 2015 to 24% as of April 2026.1 Price-insensitive demand is leaving the market just as supply may rise.
The portfolio problem
A deteriorating mix of growth and inflation creates a challenging environment for portfolio construction and positioning defensive assets like core government bonds. Whether yields rise or fall from here will largely depend on the reopening of the Strait. However, there are ways to position in core bonds that can still serve as a hedge for portfolios, such as yield curve steepeners.
If inflation proves stickier and policy rates rise, the yield curve is likely to steepen further as both short- and long-dated bond yields increase. Conversely, should the inflation shock transition to a growth shock, yields across the curve are likely to fall as central banks ease policy in response to weaker growth, with longer-dated yields declining to reflect this. However, given lingering fiscal policy risks, short rates are likely to fall more than long rates, again resulting in a steeper curve.
Rates rise, credit holds
The focus on quality has supported the investment grade market, with spreads tightening across U.S., European, and Emerging Market (EM) credit since the onset of the U.S.-Iran conflict. This tightening is less surprising when viewed in the context of the largely macro oil shock, sticky inflation expectations, fiscal concerns, and central bank repricing, rather than any deterioration in corporate health.
While spreads have tightened, yields have risen, as the surge in Treasury yields has more than offset the spread compression. For investors buying new bonds, this means they are capturing better income than before the conflict.
However, higher all-in borrowing costs will eventually tighten financial conditions and could weigh on corporate refinancing and earnings. Even within the higher-quality segment of the credit market, investors should remain mindful of the risk of wider spreads and the higher duration nature of the asset class.
High yield, beyond the duration risk
High yield bonds are more insulated from duration risk but more exposed to growth risks should the market shift from an inflation shock to a growth shock, with spreads potentially widening due to rising default expectations.
The upper end of the high yield market (BB) may have a lower yield than the overall index (6% vs. 8%) but remains attractive as a source of carry, particularly given its relative insulation from more severe default risks concentrated in lower-rated buckets.
This is reflected in spread moves since early March, with BBB, BB, and B spreads tightening while CCC spreads have widened, highlighting the market’s increasing discrimination between quality tiers and its concentration of default risk concerns at the lower end of the ratings spectrum.
Energy has a 12% weight in the U.S. high yield bond index (compared to 7% in investment-grade), this is down from its 17% peak, and the dramatic drop in oil prices led to a rise in defaults in the high-yield market. However, this also created an improvement in the quality of this segment of the bond market, which may benefit from oil prices that are higher due to constrained supply rather than decimated demand.
Not all EMD is equal
Emerging market debt (EMD) has been one of the stronger performing fixed income sectors this year, and spreads on U.S. dollar emerging market credit and sovereign bonds are at multi-year tights. However, emerging market debt faces a double squeeze. The rise in U.S. yields will lift the benchmark rate, while a potentially stronger U.S. dollar could raise the cost of servicing dollar-denominated debt for the EM world.
Investing in emerging market bonds will mean parsing the universe between those most exposed to the energy crunch, which could see their currencies and corporate fundamentals weaken, and those that may be benefiting from the wave of artificial intelligence (AI)-related capex.
Security in securitized?
Securitized products offer a compelling diversification opportunity in the current environment, with spreads across most asset classes tightening meaningfully despite elevated Treasury yields. The macro-driven nature of the yield rise, rather than any deterioration in collateral quality, has broadly supported the asset class. Floating-rate structures offer a natural hedge against the higher-for-longer rate environment, with elevated base rates sustaining attractive all-in yields and robust investor demand. Investors should nonetheless remain selective, as lower-rated tranches carry meaningful exposure to a growth slowdown should the inflation shock transition into a broader credit event.
Investment implications
The recent rise in government bond yields to multi-year highs creates what could be an attractive valuation entry point. However, concerns about inflation and fiscal positions mean that extending duration could be premature. Shorter to medium maturities offer reasonable yield without excessive exposure to further yield increases.
Credit selection matters, and high-quality investment grade remains a way to maintain a quality bias in a portfolio and leverage the more robust micro position over broader macro risks.