Bonds in Brief: Making Sense of the Macro — September issue

What are we watching?

• US-Iran conflict raises broader security risks. The US-Iran conflict is increasingly testing the boundary between regional warfare and broader security risks. In the UK, five men were arrested after vehicles carrying suspected explosives were intercepted near RAF Fairford, a base supporting US bomber operations related to the conflict. The incident highlights vulnerabilities in the transportation, communications, logistics, and personnel supporting military operations. Meanwhile, diplomacy remains intertwined with military and economic pressure, with both sides negotiating while preparing for further conflict. Potential attacks on allied infrastructure, renewed Houthi pressure on shipping or disruptions around Hormuz could extend the economic fallout beyond the region, increasing uncertainty around energy prices, inflation and global market volatility.
• The resilience of oil flows. Oil markets remain focused on disruption risks in the Middle East, but recent flow data suggest crude exports may have recovered close to pre-war levels as producers and shippers adapt through alternative routes and rising ship-to-ship transfers outside the Strait of Hormuz. This emerging logistics network is helping sustain oil flows despite ongoing security risks, suggesting a growing distinction between control of the Strait and the ability to move crude to global markets. However, considerable uncertainty remains around the durability of these arrangements, which rely on higher shipping costs, operational complexity and a contained conflict. Refined product exports also remain well below normal levels, while inventories are tight, leaving energy markets vulnerable to renewed disruption.
• Fiscal sustainability concerns. Despite one of the strongest periods of developed market nominal GDP growth in decades, the average G7 fiscal deficit remains near 6% of GDP. Bond yields have now risen to levels that, if sustained, could place debt dynamics under increasing strain in some countries. Concerns are particularly acute in countries such as France, the UK and the US, where large fiscal deficits, rising debt burdens and substantial funding needs leave public finances more exposed to a prolonged period of higher borrowing costs. For weaker sovereign issuers, this creates the risk of a self-reinforcing cycle in which higher borrowing costs further erode fiscal positions, making fiscal sustainability an increasingly important driver of differentiation in bond markets.
• Corporate issuance on record pace. US investment-grade (IG) corporate issuance is running at a record pace in 2026, well ahead of prior years. September brought another blockbuster deal, with Paramount Skydance raising US$32 billion, the fifth-largest US IG bond offering on record. September also saw exceptionally strong primary market activity across both euro and sterling IG markets. Euro IG issuance surpassed €100 billion, while the sterling market recorded its busiest month since 2009. Despite heavy supply, spreads remain relatively tight, reflecting strong demand for high-quality credit. While tight spreads limit upside, higher global yields have kept all-in corporate yields attractive, helping the market absorb record issuance.

Where are the opportunities?

• We continue to believe that total return fixed income strategies unconstrained by benchmarks are best positioned to navigate a backdrop of persistent inflation, tightening monetary policy and elevated market volatility. As central banks increasingly prioritise inflation risks over growth concerns, the potential for policy surprises and market dislocations is rising. While structural tailwinds — including fiscal support, deregulation, and AI-driven capital investment — remain constructive for growth, elevated valuations across many fixed income sectors leave little room for error. In this environment, flexibility, active duration management and disciplined security selection will be critical drivers of returns.
• In our view, today’s increasingly volatile and uncertain market environment underscores the growing appeal of an allocation to core fixed income, be it aggregate or credit only. We think higher-quality fixed income remains attractive from both an income and capital-protection perspective, providing a combination of carry and significant potential upside in a risk-off environment. We continue to view all-in yields as appealing for investors looking to de-risk or diversify away from domestic government bonds, providing a potentially smoother return profile.
• European investors can seek to embed resilience and enhance income potential through either a bond allocation in local markets or by going global, particularly if they are concerned about the extent of their exposure to the US or USD-denominated assets. Doing so could also potentially provide a yield pick-up, as hedging costs mean USD-denominated investments have lower yields than EUR- or GBP-denominated equivalents.
• We think emerging market debt (EMD) offers potential as both a return driver and a diversifier in fixed income allocations, particularly for European investors. While EMD has historically been more cyclical and volatile than its developed market counterparts, there are reasons to be structurally positive as risks are increasingly originating from developed markets amid disruptive US policy dynamics. Many EM economies also benefit from muted default forecasts, reflecting solid fundamentals across growth, fiscal and external metrics. Despite heightened geopolitical uncertainty, we think select exposure to EMD could make a positive contribution to a well-diversified portfolio, mainly through carry and USD weakness.
• In our view, high yield remains attractive from an outright yield-to-worst perspective but warrants a cautious approach given market uncertainty and current spread levels. The robust carry may make this a good equity substitute should investors want to de-risk. We advocate an “up-in-quality” issuer bias and careful credit selection but remain cautiously optimistic that this sector can continue to perform well.