Fixed Income Focus May 2026

Summary

1. The Fed moved to a symmetric view: The April job report was again solid, and the risks for inflation are clearly tilted to the upside. The Fed should be on hold this year.

2. ECB under pressure: We continue to expect the policy rate of the ECB to remain unchanged this year. We do however see rising risks for a rate hike if we do not see a de-escalation of the conflict by the end of the month.

3. Opportunities in core eurozone govies: Positive stance on core eurozone govies. We favour maturities of 7-10 years.

4. Positive opinion on UK bonds: Yields pushed higher by the political crisis after the local elections. We keep a positive stance on UK government bonds. We keep our target on 10-year UK government bond yields at 4.30%.

5. Selective opportunities in corporate bonds: We prefer EUR and GBP IG corporate bonds (Positive view) over USD IG bonds (Neutral view).

6. We keep a negative stance on corporate high yield bonds. For fallen angels as well as rising stars, we keep a neutral view:  Yield spreads fell back further and do not remunerate for the underlying risks. Even if recession risks remain low, they are still higher compared to the environment before the Iran strikes.

7. Neutral view on emerging market bonds in local and hard currency: We see less potential for USD weakening and this is not supportive for this asset class. The risk premium is not sufficient at this stage. 

Central banks

Monetary authorities still feel the heat

European Central Bank (ECB)

The fact that the conflict in the Middle-east is not coming to an end  remains a headache for the monetary authorities and especially for the ECB. The key will be to monitor second-round effects as companies could pass on energy cost increases. The latest wage data showed that underlying wages are not re-accelerating. The rise in the headline path through 2026 mainly reflects the fading drag from past one-off payments, not fresh wage pressures. The evolution of inflation remains as expected. Headline inflation rose above 3% while core inflation has yet to show some effects. Producer prices remain low, but  the supply chain pressure index suggest an imminent rise.

Outlook: The balance of risks has turned less favorable. We are not yet seeing second-round effects, but long-term inflation expectations are under pressure. We continue to expect the policy rate of the ECB to remain unchanged this year. We do however see rising risks if we do not see a de-escalation of the conflict by the end of the month.

US Federal Reserve (Fed)

We believe the bias has moved to a symmetric one. The employment report was stronger-than-expected especially in terms of job creation. Initial jobless  claims have been falling top record lows. Other indicators such as job openings and the consumer perception on whether jobs are plentiful versus hard to get are less optimistic. Unusual effects on labor supply linked to immigration are making it more difficult to have a clear view on the underlying trend. Wage grow remains well behaved and the Atlanta Wage tracker remains on a downward trend. Expectations about the future path of rates has changed somewhat after the job report. Based on futures, the market expects no rate moves this year.

US long-term inflation expectations remain anchored. Market measures of inflation expectations and consumer surveys are close to the long-term average.

Outlook: Ultimately, we continue to believe that monetary policy will be determined by the outlook, and the policy rate will be on hold this year.

Topic in Focus

Risk assessment related to AI investment boom 

We forecast that the supply from IG AI hyperscalers will reach $250 bn. Their capital spending (Capex) is being repeatedly revised upward. After the first quarter earnings updates from issuers, we now expect 2026 Capex to be $725 bn—almost double the level of mid 2025. Capex is growing faster than operating cash flow, which creates higher funding needs. Already this year, IG AI hyperscaler supply has passed the 2025 record and is on track to meet our $250 bn target for 2026.

For the United States, BNP estimates $1.8 trn of IG supply in 2026. We expect corporate spending to lift supply by about $1.2 trn, driven largely by AI related Capex. We consider the supply risk manageable through careful sector and curve allocation. Supply from Technology, Media and Telecommunications (TMT) is already very well flagged and may be near its peak.

Rising risks and low US corporate spreads: The US corporate‑bond market is  still driven by the AI theme It is not only about re-leveraging but also its potential to disrupt other sectors.

At the same time, the technology sector as a whole is under stress, as investors question the extreme equity valuations. Nevertheless, spreads are still close to, or even below, historical lows. In this environment we see more value in high‑quality investment‑grade corporates than in high‑yield issuers, especially in the eurozone and the U.K.

What do we need to monitor? The key indicator to watch is the relative spread between high‑yield (HY) and investment‑grade (IG) bonds in the US (see chart below). An increase in debt‑raising by some tech firms, or doubts about the returns from AI‑related investments, could push this spread higher. Although the EU has less direct exposure to AI, the disruptive effect may still materialize, so the situation should be monitored closely. The other key indicators will be the evolution of IPO’s and the potential for major M&A at a high premium.

Government Bond yields

Positive eurozone and UK

Buying opportunities in core eurozone long-dated bonds: We saw the 10-year government bond yield in Germany coming back closer to 3.10%. This is still well above our forecast of 2.75%. As discussed in the section on the ECB, we do not expect core inflation to rise durably. The recent move in breakeven rates seems exaggerated (see previous page). We favor maturities of 7-10 years.

Positive stance on UK government bonds: The municipal elections brought sweeping losses for traditional parties. The two most likely scenarios are the status quo and a fiscally responsible shift to the left. Volatility would remain high, but we do not expect a further rise in yields. We thus keep a positive recommendation.

Neutral stance on US government bonds: The 10-year yield has been hovering in the range of 4.25-4.40%. Inflation expectations, as measured by the breakeven inflation, remain relatively stable. US Treasury yields will probably remain biased to the upside over the coming year, due to the risk of increasing sovereign debt. We keep a target of 4.25% but risks are to upside.

Selective Opportunities in Corporate bonds

Prefer quality in Europe

Positive view on Corporate investment grade bonds eurozone and UK: 

In  In the euro area, fundamental risks are still expected to be low because several “shock absorbers” are in place. The fourth quarter 2025 earnings showed that the deleveraging trend kept going, with net leverage improving and overall leverage staying structurally low. EBITDA growth remains strong, and balance sheets look healthy, so we think the euro zone’s fundamental risk will stay low. The main thing that could change this outlook is a longer lasting blockage of the Strait of Hormuz, which would hit oil supplies and markets. Because of the solid data, we feel more comfortable concentrating on high quality. € BBB has lagged recently, but sits near generational tights to Single-A. In the United States, the fourth quarter 2025 earnings report showed that liquidity – measured by cash to debt – was unchanged and leverage remained stable at the low levels that have persisted since the 2021 deleveraging wave. The pressure could be rising for the Fed and this risk is not really priced.

High frequency indicators such as initial jobless claims suggest the economy remains relatively insulated from the Middle East energy shock. The risk of higher inflation is however underpriced. Spreads are extremely low in the US and do not remunerate well for the risk.

Caution on Corporate high yield bonds

As mentioned earlier, spreads have retraced the rise that followed the cease‑fire announcement—a surprising development, given that there is no clear evidence the conflict has actually ended. Current spreads no longer compensate investors for the underlying risks. Even though recession risks remain modest, they are still higher than they were before the Iran strikes. BB‑rated spreads are especially low by historical standards. In addition, the high yield‑to‑investment‑grade spread remains compressed and does not reflect the heightened risk environment.

We maintain our negative view on corporate high‑yield bonds and neutral stance for both fallen‑angel and rising‑star issuers.