Recent US Treasury buyback activity has contributed to heightened volatility in long-end interest rates, although credit spreads have remained notably resilient.
Exhibit 1: Credit spreads resilient
Source: Bloomberg as of 21 Aug 2026
While a further rise in long-end yields could eventually pressure credit valuations by tightening financial conditions, that risk has yet to materialise meaningfully. US financial conditions remain broadly accommodative, as reflected by the Bloomberg US Financial Conditions Index, which continues to indicate a relatively loose backdrop for risk assets.
Exhibit 2: US Financial Conditions Index
Source: Bloomberg as of 21 Aug 2026
Although investors continue to grapple with macroeconomic uncertainty and questions surrounding the sustainability of the AI-led investment cycle, corporate fundamentals remain largely stable across most sectors in US IG.
As a result, IG credit spreads should remain largely rangebound in the near term, unless the market experiences another significant bout of rate volatility or a further sharp rise in global long-end bond yields.
The immediate focus for credit markets centers on two key events in the coming weeks: the Jackson Hole symposium and the seasonal post-Labour Day surge in corporate bond issuance.
Consequently, while absolute yields remain attractive and corporate fundamentals continue to provide support, we believe spreads could remain under modest pressure, given current tight levels and near-term event risks.
Within the credit market, spread curves have displayed divergent behaviour across maturities. The long-end of the curve generally stayed range bound and is around mid-point (55%) of its three-month range. In contrast, the short and belly of the curves have steepened, with the 3s5s curve and 5s10s curve reaching 74% and 82% of its three-month range respectively. Consequently, this has improved relative value in the short and belly of the curve, while the long-end of the curve could be vulnerable if rates volatility increases further.
Exhibit 3: US IG spread curves
Source: Bloomberg as of 21 Aug 2026
The broader rates backdrop has also undergone a notable shift. As of 24 August 2026, the UST 2s30s curve has steepened by approximately 33bps since reaching its one-year low in June as 30Y yields climbed to 5.25%, their highest level since mid-2007, reflecting a wider global bear-steepening trend.
Importantly, the rise in nominal UST yields has been driven primarily by higher real yields rather than inflation expectations. While inflation expectations remain relatively subdued on a year-to-date (YTD) basis, they have gradually edged higher over the last two months.
|
UST |
Current |
YTD chng (bps) |
||||
|
Nominal yield |
Real |
Breakeven yield |
Nominal yield |
Real |
Breakeven |
|
|
2Y |
4.24 |
1.90 |
2.33 |
76 |
72 |
4 |
|
5Y |
4.42 |
2.09 |
2.34 |
70 |
63 |
7 |
|
10Y |
4.73 |
2.40 |
2.33 |
57 |
48 |
9 |
|
30Y |
5.27 |
3.02 |
2.25 |
43 |
40 |
3 |
Source: Federal Reserve Bank of New York, Bloomberg as of 21 Aug 2026
Market pricing for the front end of the yield curve has undergone several notable shifts this year. Investors began the year anticipating policy easing by the Fed, then reassessed the outlook and priced in one to two rate hikes by mid-2026. More recently, softer labour market indicators and contained inflation data have led to a partial reversal of those expectations. Based on futures pricing as of 21 August 2026, markets now anticipate roughly one rate hike by the end of 2026.
Another development worth monitoring is the evolving relative attractiveness of Japanese government bonds (JGBs) versus hedged USD fixed income assets. Japan remains one of the largest foreign holders of USTs, and any meaningful reallocation by major domestic institutional investors, including life insurers and the Government Pension Investment Fund (GPIF), could have significant implications for UST demand and long-end US yields.
From a fixed income perspective, the more critical consideration is the trajectory of Japanese interest rates. As JGB yields continue to rise and the yield differential between Japan and the US narrows, domestic investors may increasingly view local fixed income assets as a compelling alternative to hedged USD investments. Such shifts could gradually influence portfolio allocations among large institutional investors, potentially contributing to greater volatility across both the UST and US IG credit markets.
Japanese demand for USD IG credit is largely driven by relative yield opportunities after accounting for foreign exchange hedging costs. The recent decline in USD/JPY hedging costs has enhanced the attractiveness of hedged USD corporate bonds relative to JGBs and reduced the yield advantage previously enjoyed by domestic corporate bonds, as illustrated below.
Overall, the relative appeal of USD and JPY-denominated credit remains highly dynamic. Future allocation decisions will depend on a combination of factors, including Bank of Japan (BoJ) and Fed policy trajectories, interest rate differentials, FX hedging costs, exchange rate movements, and broader economic and political developments.
Exhibit 6: JPY hedged yield comparison
Source: Bloomberg as of 21 Aug 2026
For credit investors, the key risk remains rates volatility. Historically, periods of sharply rising rates volatility have been associated with wider credit spreads. While spreads have remained resilient thus far, a sustained increase in volatility could eventually trigger spread widening.
Exhibit 7: Rates volatility vs US credit spreads
Source: Bloomberg as of 21 Aug 2026
At the same time, the carry profile IG credit remains compelling. The total return breakeven for US IG bonds has risen to approximately 84bps, meaning yields would need to increase substantially, by 84bps to roughly 6.3%, before investors begin to experience negative total returns over the coming year. This continues to provide a strong technical underpinning for the asset class.
That said, while the carry cushion is healthy, the spread-only breakeven of 12bps remains near its historical lows, underscoring that current IG spreads at 80bps provides minimal protection against any spread widening episode.
The two metrics tell a consistent story: US IG is well-insulated against rate moves but highly vulnerable to spread widening, all else equal.
From a policy perspective, the US Treasury could potentially support long-end bonds by adjusting the duration profile of issuance or by further expanding its buyback programme. However, such measures are unlikely to materially alter the longer-term direction of yields. More durable downward pressure on long-end rates would likely require structural changes, including meaningful fiscal consolidation, a sustained decline in inflation, or slower economic growth.
In our view, the market's focus on US Treasury issuance alone overlooks another important driver of higher long-end yields: the significant surge in capital demands associated with the AI investment cycle. Hyperscaler CAPEX, data-centre construction and power infrastructure investment are creating sustained demand for capital on a scale not seen in decades. In effect, markets are increasingly pricing in a world where capital is more constrained and therefore commands a higher cost.
Viewed through this lens, the rise in long-end yields reflects not only growing government borrowing requirements, but also expectations of persistently strong capital demand from the private sector. If investors continue to believe that large structural fiscal deficits will coexist with elevated inflation and higher real rates, they are likely to demand greater compensation for owning long-duration assets.
Given the continued uncertainty surrounding Fed policy, inflation dynamics, fiscal developments and long-end rate behaviour, we maintain a Neutral duration stance at the portfolio level. While our strategic preference remains for portfolios to operate within a 3-7Y duration range, we currently favour positioning closer to the midpoint of our asset allocation framework over the next few months (i.e. approximately five years), rather than extending duration risk aggressively.
This balanced stance provides flexibility across a range of potential outcomes. A deterioration in economic growth or downside surprises in inflation could support extending duration exposure, while persistently sticky inflation, renewed fiscal concerns or higher term premia would argue for maintaining a shorter-duration posture.
Looking ahead, market attention will be firmly focused on Kevin Warsh's speech at Jackson Hole on 28 August 2026, as well as any announcements from US Treasury Secretary Scott Bessent regarding fiscal consolidation measures. Both events could provide important signals for the outlook for rates, UST supply, and broader risk markets heading into the final months of the year.
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