Fixed Income Focus September 2026

Summary

1. The Fed hawkish : We continue to anticipate a single rate increase in December, as oil and energy prices are projected to fall gradually. The recent Fed communication also supports that. ​
   
2. ECB to hike in September: The ECB’s latest bulletin underscores resilient growth, even as recent inflation data remains significantly above the 2% target. Consequently, we now anticipate a rate hike in September. ​
   
3. Sharp rise in government bond yields especially in the US:  The move was driven by rising real yields. Mainly due to increased demand for capital and a higher term premium due to Fed policy uncertainty. We reiterate our 12-month target of 4.50% for the 10-year U.S. The 10-year Treasury yields could briefly overshoot toward 5% in the near term.​
   
4. We upgrade again core Eurozone govies from Neutral  to Positive. The 10-year German Bund yield rose to 3.30%, while the Eurozone average 10-year yield was above 3.7%. We reiterate our 12-month target for the German 10-year yield at 2.75%​
   
5. We keep a Neutral opinion on UK bonds:  U.K. Yields followed the global trend rising above 5.20%. ​
   
6. Selective opportunities in corporate bonds: We prefer EUR IG corporate bonds (Positive view) over USD IG bonds (Neutral view). We downgrade UK IG bonds to neutral. ​
   
7. We keep a neutral opinion on high yield corporate and Emerging Market bonds:  Spreads remain very low and expected return are too low. EM bonds, the three primary drivers—valuation, currency outlook, and monetary policy expectations— are not supportive at this stage. 

Central banks​

The ECB and the Fed with one more rate hike​

​European Central Bank (ECB) ​

The latest economic bulletin broadly reinforces the Governing Council's assessment from the July meeting. The Council notes that the US-Iran conflict has had uneven but overall limited effects on euro area activity, leaving growth more resilient than initially feared. Inflation is projected to hover around 3% this year, though the outlook remains clouded by energy price volatility and the speed of price pass-through. While the energy shock has not yet generated clear second-round effects, the Council cautions that wage adjustments may lag and that a temporary easing of tensions could mask underlying pressures. The latest inflation data for August reinforces recent trends: preliminary headline inflation was 3.3%, compared to 2.9% in July, which was in line with expectations. Core inflation fell to 2.4%, down from 2.5%, meeting the expected figure.​

Outlook: We believe the ECB will act preemptively rather than waiting for these second-round effects to materialize. Consequently, we have revised our outlook for the ECB and now anticipate a single rate increase in September.​

US Federal Reserve (Fed)​

Chair Kevin Warsh surprised markets with a hawkish speech at the Jackson Hole symposium, triggering a repricing of expectations for the September meeting (see chart below). Warsh noted he was "impressed" by economic resilience despite mixed data and declining economic surprise indicators. He also expressed unease regarding the 0.246% month-on-month July core CPI print. Other Fed members have similarly stressed concerns regarding core inflation, suggesting a more hawkish stance. In our July report, we warned that a shift in Fed communication could increase uncertainty and exert upward pressure on bond yields; this has indeed materialized recently. Notably, Warsh used the Jackson Hole speech to add nuance, reiterating a commitment to the 2% PCE inflation target and hinting at a reaction function consistent with previous FOMC policy. At this stage, however, markets remain unconvinced, and further commitment may be required to compress the term premium in the bond market (see next page).​

Outlook: We continue to anticipate a single rate increase in December, as oil and energy prices are projected to fall gradually. In contrast, markets are currently pricing in approximately two hikes (see chart below).​

Topics in Focus​

Understanding the Recent Upswing in U.S. 10‑Year Treasury Yields​

U.S. 10‑year Treasury yields rose sharply since late June. At its most basic, a bond’s yield can be broken down into two components: expected inflation and the “real” yield, which is the return after inflation is stripped out. Despite renewed Middle‑East tensions and elevated oil prices, long‑term inflation expectations have remained surprisingly steady, indicating that the recent increase is driven primarily by higher real yields (see chart below). What is behind the rise in real yields? In practice, the real yield incorporates a term premium for committing capital over longer horizons rather than rolling over a series of short‑term bonds. By subtracting this term premium from the observed real yield, we obtain a “core” real yield1—​the purchasing‑power return that reflects the underlying balance of capital demand and supply in the economy. U.S. yields have been pushed upward primarily by higher real rates, which in turn reflect an increasing demand for capital and a widening term premium. ​

​Demand for capital is being amplified by two factors: (1) the massive AI related spending and (2) the sustained high level of public deficits. Assuming supply remains roughly unchanged, this heightened demand helps explain a large part of the recent yield increase. At the same time, the term premium has been climbing over the past few weeks. We think that the shift in Fed communication policy has generated more uncertainty and lifted the premium.​

The Treasury’s newly announced program to purchase long-dated bonds is unlikely to exert a lasting influence; market participants are expected to respond more to policies aimed at fiscal consolidation and to clearer guidance from the Federal Reserve. The nuances provided by Warsh at Jackson Hole have had little impact at this stage.​

We maintain our 12-month target of 4.50% for the 10-year U.S. Treasury yield, while acknowledging the risk that yields could temporarily overshoot toward 5% in the coming months.​

Government Bond yields

Upgrade to positive on core eurozone Govies​

Upgrade Core Eurozone government bonds to positive: Eurozone core sovereigns upgraded from Neutral to Positive. Yields have rebounded due to oil price volatility and higher issuance from increased capital needs. As we believe the German Bund's fair value remains below 3%, we expect attractive returns at these levels. We favour maturities of 7-10 years. ​

Neutral Stance on UK Government Bonds: U.K. Yields followed the global trend rising above 5.20%. Markets are expected to remain cautious; lingering fiscal uncertainty ahead of the next budget may sustain a small risk premium.​

Neutral Stance on US Government Bonds: U.S. 10-year yields rose sharply, driven by increased demand for capital and a higher term premium. Yields may overshoot our 12-month target of 4.50% in the near term. Too early to come back. ​

Selected opportunities in corporate bond markets​

Prefer eurozone high grade corporate bonds​

The macro-fundamental environment remains benign for credit. The central question moving forward is whether increasing corporate supply is effectively crowding out Treasuries. We anticipate that higher net IG issuance will lead to a further expansion in corporate bond supply, increasing their relative share within total fixed-income supply. UBS expects duration-adjusted Treasury supply to remain relatively stable through 2027 thereby mitigating the near-term risk of excess supply. The key to estimate the future supply of corporate bonds is the expected return on AI investments relative to current yields. While we see no imminent risks at this stage.​

We prefer eurozone IG: Fundamentals improved following strong earnings across most sectors, which helped to moderate the upward trend in net leverage. In light of this earnings recovery, we expect net leverage to remain broadly stable. Consistent with the previous quarter, EBITDA growth underpinned a modest improvement in leverage, even as net debt edged higher.​

We are neutral on US IG: Fundamentals remain resilient overall. Hyperscalers delivered a strong Q2 earnings season, bolstered by accelerating growth in cloud and AI revenues, with capital expenditures projected to surge beyond $800bn in 2026. While secular AI funding requirements continue to climb, valuations remain near recent highs. Robust earnings growth is helping to contain net leverage, despite accelerating debt growth. As noted in previous sections, we see a risk of an overshoot in Treasury yields, which poses a secondary risk to US IG given its high duration sensitivity.​

We keep a neutral stance on High yield bonds: We do not expect these bonds to outperform on a risk-adjusted basis. High-yield corporate spreads remain near historical lows; while this tightness can be partially justified by ongoing improvements in credit quality across the asset class, the potential for further spread and yield compression appears limited. Consequently, any deterioration in the economic or interest rate environment could have a disproportionate impact on valuations.​

EM Bonds remain quite resilient​

We keep a neutral stance on Emerging Market Bonds​

Emerging market (EM) growth has remained resilient over recent months; however, the recent oil shock has been quite severe. While inflation has remained contained thus far, rising costs for fertilizers, petrochemicals, and transport threaten to trigger broader price pressures, a risk exacerbated by the recent climb in key commodity prices.​

Most EM central banks have either held rates steady or implemented cuts in recent weeks, with the notable exception of South Africa, which recently hiked rates. We see little potential for further easing over the coming months.​

EM local currency bond spreads moved higher, likely reflecting heightened global currency uncertainty. Conversely, EM hard currency bond spreads declined, reaching a 20-year low (see chart below).​

Neutral Stance: The three key performance drivers are: (1) valuation, (2) the outlook for the dollar, and (3) the potential for EM central bank rate cuts.​

Valuation is not supportive: As shown in the chart below (left), the risk premia—measured by yield spreads—remain compressed especially for EM hard currency bonds. This suggests limited upside for future returns.​

Currencies are range-bound: A weaker dollar would benefit EM local-currency bonds, but dollar upside appears limited for the coming months. ​

No support from Monetary policy : Inflation has reversed course, and the risks are biased to the upside. Market expectations suggest further hikes going forward (see table below). This outlook may shift in the coming months, however, as we anticipate a de-escalation in geopolitical tensions and a gradual reopening of the Strait of Hormuz.​

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