Update Bonds: Higher quality favoured
US ten-year Treasury yields stand at 4.12%, remaining in a trading range since 10 January 2025. The ten-year Treasury yield is the pivot point for the short end of the yield curve, moving lower due to Federal Reserve rate expectations and the long-end moving higher (also expressed as a steepening).
The long-end of the yield curve is challenging the 5% yield level, due to all kinds of nervousness related to the Fed’s independence, inflation remaining significantly above the 2% target level and the issues related to the sustainability of US debt.
Since the beginning of September this nervousness has declined somewhat, therefore 30-year US Treasuries are trading slightly lower at around 4.70%. While it’s true that the Fed appears willing to lower interest rates further, the recent minutes from its September policymakers meeting revealed that many members have expressed caution, driven by concerns over percolating US inflation. We do not expect another rate cut this year, but more to come in 2026. Broad consensus is that the bulk of the cuts will be delivered before the end of Fed Chair Jerome Powell’s term in June 2026. The latest challenge for the Fed is how to act during the undefined period of a US government shutdown, when economic data is not being updated and there is upside risk from inflation.
The challenging interplay of growth and inflation in the US means that the spread outlook is unusually binary. Much will depend on how corporates deal with tariff costs and the evolution of the US labour market. The wide range of Fed policy outcomes is better reflected in parts of the rates market, but less so in corporate risk spreads. As a consequence, there is a strong positive quality ratings momentum within the Investment grade (IG) and High Yield (HY) Corporate index.
The BBB-rated quality share of the IG-market is now at a 20-year low of 7.9%. Among high-yield bonds, the share of B-rated or lower credits in the segment is also at a multi-year low of 19%. However, in the leveraged loan market (offering access to riskier debtors) the B- or lower rated segment has a market share near the 20-year peak of 31%. In this context it should not be a surprise that the latest bankruptcies (First Brands and others) are impacting the leveraged loan and the private debt markets more than the more secure IG and HY corporate credits. All in all, the corporate debtors (IG and HY) are benefiting from a trend of improving credit profiles, leading to upgrades by rating agencies and resulting in their risk premiums (risk compensation) declining. These IG and HY corporates continue to hold stable at their tight multi-year levels, while the trend to further tighten appears to continue, although at a slower pace. Our preference remains for higher quality bonds and a neutral duration.