Weekly market commentary

Government bond yields have reset higher across the U.S., Europe and Japan since 2020-21. See the chart. The recent repricing of U.S. policy expectations has provided a fresh catalyst. Higher Treasury yields and a stronger dollar have put renewed pressure on the yen, making the Bank of Japan's gradual normalization more challenging and pushing Japanese government bond yields higher. Japan's domestic backdrop – including rising inflation expectations and concerns over fiscal expansion – have amplified that move. Long-dated forward rates implied by JGBs are now around 5%, versus roughly 6% in the U.S., 5.3% in France, 5.5% in Australia and 6.5% in the U.K. If even Japan – long an outlier because of decades of deflation and ultra-loose monetary policy - is now trading broadly in line with its developed-market peers, we think that reinforces our view that the global rates reset is real and significant.

Higher yields have created a stronger environment for generating durable income. Investors no longer need to rely on broad bond indices or extend far out the yield curve to earn attractive income. Yet not all income is equal. The key question is whether investors are being adequately compensated for the risks they assume. Japan illustrates why. The BoJ's gradual approach to tightening has helped keep the global repricing in rates relatively orderly, but increasingly crowded short-yen positioning warrants close monitoring. The yen remains an important funding currency for global carry trades. While higher JGB yields have made the yen a less attractive funding currency than in the past – reducing the risk of a repeat of the 2024 carry squeeze - any abrupt shift in BoJ policy could trigger an unwind in those trades and ripple across global markets.

Higher yields have also changed the role of long-duration government bonds in portfolios. Greater uncertainty about inflation, higher government borrowing and rising term premia mean they no longer provide the same reliable ballast during risk-off episodes. At the same time, investors have far more options for generating income than they did just a few years ago. Our analysis shows that over 80% of major global fixed income assets now yield above 4%, up from just 6% five years ago. The Global Aggregate currently yields 3.8% with 5.1% volatility, compared with an equally weighted income basket yielding 5.5% with 4.3% volatility, reinforcing the case for a more selective approach.

We therefore favor focusing on areas where we think investors are best compensated for risk. Within government debt, we favor the front end and belly of the U.S. and European yield curves, as well as selected local-currency emerging market debt, where rates have repriced materially and fundamentals have improved. Beyond government debt, we favor selected investment grade credit, higher-quality high yield and direct lending. In Japan, however, we continue to prefer equities over government bonds. We continue to see a more constructive backdrop for Japanese equities as the economy emerges from decades of deflation and the BoJ gradually normalizes policy.

Higher yields have made durable income an opportunity again, but investors should focus on areas where they are best compensated for the risks they take.

The S&P 500 ended the week higher, leaving the index up 11% for the year and less than 1% off its record high, even as sharp swings in semiconductor stocks and renewed tensions between the U.S. and Iran kept investors focused on geopolitical risks. The Nasdaq advanced 1.7%. Brent crude is back above $76 a barrel, while the U.S. 10-year Treasury yield rose around 8 basis points to 4.55%. We think markets are continuing to look through near-term geopolitical shocks while remaining focused on the broader repricing in rates and resilient corporate fundamentals.

This week we watch U.S. inflation data for signs that earlier increases in energy and producer costs are passing through to core prices. Recent CPI details showed limited spillover, but underlying inflation remains too firm to be confident in a return to 2%, keeping the Fed on hold. Markets are still pricing one quarter-point hike by the end of 2026.