Fixed Income Focus March 2026

Summary

1. The Fed suggests greater symmetry in the policy outlook: We still expect the FOMC to cut one more time. Indeed, we expect a de-escalation of the conflict in the Middle-East in the coming weeks and gradual fall of oil prices towards 80$.

2. ECB kept the policy unchanged: We expect policy rates for the ECB to remain unchanged this year and forecast the first hike in 2027. Headline inflation will rise but we do not expect major second round effects. Core inflation is not expected to rise much.

3. Opportunities in eurozone govies: We keep a neutral stance on eurozone government bonds. A move above 3% could be a good opportunity to buy eurozone longer maturity bonds.

4. Opportunities in UK bonds:  Government bond yields are well above our targets. Current yield levels are attractive especially on longer maturities. We also keep a positive view on UK investment grade corporate bonds.

5. Selective opportunities in corporate bonds: We prefer EUR and GBP IG corporate bonds (Positive view) over USD IG bonds (Neutral view) given the supply dynamics and the level of spreads.

6. We downgrade corporate high yield bonds to negative and fallen angels as well as rising stars to neutral: The risk-return trade-off has deteriorated further as the probabilities of an alternative scenario with oil prices remaining above  USD 100 have risen.

7. We also downgrade emerging market bonds (local currency) to neutral. Similar reason as for corporate high yield bonds. Less potential for USD weakening is not supportive for this asset class. The risk premium is not sufficient at this stage. 

Central banks

Monetary authorities should look through the rise in headline inflation

European Central Bank (ECB)

The ECB  kept policy rates on hold at their meeting March 19. The communication was in favor of a more risk-conscious tone and suggested to adopt a wait-and-see approach for now while emphasizing that it won't hesitate to act to ensure price stability if required. The ECB suggested that they are positioned to deal with the increased uncertainty as inflation expectations remain broadly stable while the economy shows signs of resilience. Even if oil prices stay above  USD 100 for one or two months, core inflation is not expected to rise a lot. Indeed, headline inflation would rise as energy prices are included in the index but for core inflation to rise, it would need costs increases to be passed on to final prices of other goods and services. That seems unlikely at this stage.

Outlook: We expect the policy rate of the ECB to remain unchanged this year and forecast the first hike in mid‑2027. 

US Federal Reserve (Fed)

The Fed maintained an easing bias and projections for some additional policy easing, The uncertainty about the Iran war could push towards a greater symmetry in the policy outlook. Powell suggested some confidence in the stability of the labor market despite recent disappointing data. He argued that zero job creation is “about what the economy needs” in the context of restrictive immigration policy. Growth forecasts were revised up at the meeting. They now incorporate a stronger productivity assumption related in part to AI. The recession risk was not prominent in the communication.

Outlook: We still expect the FOMC to cut one more time in September 2026. Indeed, even if oil prices fall, it is unlikely to see a pull back to levels seen before the Iran strikes. Even in such a scenario it is unlikely that core inflation rises durably as second round effects should be quite moderate. 

Government Bond yields

Buying opportunity in the eurozone

Yields jump especially in Europe: We saw a V-shape rebound in 10-year government bond yields since the beginning of the month (see chart below). That corresponded with the military strikes in Iran.

Buying opportunities in the eurozone: the 10-year Bund yield is trading close to 3%, well above our forecast of 2.75%. We do not expect core inflation to rise durably. The recent move in breakeven rates seems exaggerated (see next page). A move above 3% would be a good opportunity to buy eurozone longer maturity bonds. We keep our target on UK government bonds at 4.40% and keep a positive recommendation.

Neutral stance on US government bonds: Yields in the US have not been rising considerably in the  US despite the Iran conflict (see chart). Inflation expectations remain relatively stable. US Treasury yields will probably remain biased to the upside, due to the risk of increasing sovereign debt. The weakness in swap spreads further increases the risk of a self-reinforcing feedback loop of higher Treasury yields. 

Topics in Focus

Opportunities and risks on the UK market

The economic Outlook: With the current energy price shock, the UK faces a similar fragmented political environment compared to its European peers. The additional challenge is that economic growth is more vulnerable. Although the economy is less directly exposed than the eurozone, due to its lower energy intensity and a relatively small manufacturing sector, the inflationary shock could reduce consumer confidence and spending. Some structural properties of the UK economy needs also to be considered. First, the UK has a structurally low level of gas storage. Second, the Ofgem* price cap mechanically slows down the speed of transmission to household energy prices by one or two quarters. This contributes to the dynamics seen in 2022, when UK energy price shocks were of a similar size as in the eurozone but peaked later.

Depending on the duration of the supply shock, the BoE could look through the impact, given recent evidence that domestic inflationary pressures are falling back.

*The Office of Gas and Electricity Markets in UK

We like UK govies and IG corporate bonds

More easing to come:  The Bank of England left its policy rate unchanged at 3.75 % in March. The tone was more hawkish-than-expected, sending a strong signal that the central bank is prepared to act in response to the energy price shock. The base case is still that the BoE will be able to cut rates later this year as oil prices move towards 80$.

Outlook for yields: Yields on government bonds are  between 80 and 50 basis points above our targets (see chart below). When we decompose the 10-year nominal yield we see real yield falling but breakeven inflation rising since late February. On a net base, nominal were moderately higher around 4.75%. Inflation swaps (5Y5Y) price around 3.10% while the breakeven 10Y was around 3.50%. CDS (5-year) remain low and well below the average of the last 120 years. Current yield levels are attractive especially on longer maturities. 

Outlook for corporates: The outlook for corporate bonds remains positive mainly for the carry. Spreads are close to a 20-year low, and we see no downside from here. We keep a positive view.