With credit curves already steep and the U.S. Treasury curve expected to steepen further, the optimal risk-reward in corporate bonds lies in the 5 to 10-year maturity range. This specific positioning in both U.S. and European markets is key to capturing value from 'carry and roll down' dynamics.
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In 1935, amidst massive economic uncertainty following the Great Depression, a new AA-rated corporate bond yielded just 70 basis points over Treasurys. This historical precedent, nearly identical to today's spreads, shows that low credit spreads are not necessarily a sign of complacency and can persist even if economic conditions worsen, challenging typical risk-pricing assumptions.
Contrary to fears of a spike, a major rise in 10-year Treasury yields is unlikely. The current wide gap between long-term yields and the Fed's lower policy rate—a multi-year anomaly—makes these bonds increasingly attractive to buyers. This dynamic creates a natural ceiling on how high long-term rates can go.
Uncertainty around the 2026 Fed Chair nomination is influencing markets now. The perceived higher likelihood of dovish candidates keeps long-term policy expectations soft, putting upward pressure on the yield curve's slope independent of immediate economic data.
A surge in European retail investment into Fixed Maturity Products (FMPs) creates a stable, long-term demand base for short-dated corporate bonds. This "locked-up" capital anchors the short end of the curve, providing stability during volatile periods and potentially distorting risk pricing.
Germany's finance agency signaled it would adjust debt issuance in response to a steepening yield curve. This sensitivity acts as a structural anchor on intermediate-term yields, creating a potential outperformance opportunity for German bonds versus US and UK debt, which face greater fiscal pressures.
A high-conviction view for 2026 is a material steepening of the U.S. Treasury yield curve. This shift will not be driven by long-term rates, but by the two-year yield falling as markets more accurately price in future Federal Reserve rate cuts.
A steep yield curve makes fixed annuities more attractive for consumers. Life insurers sell more of these products and invest the proceeds into spread assets like corporate bonds, creating a powerful, non-obvious demand driver for the credit markets.
When the Treasury does increase coupon issuance, it will concentrate on the front-end and 'belly' of the curve, leaving 20 and 30-year bond auctions unchanged. This strategy reflects slowing structural demand for long-duration bonds and debt optimization models that favor shorter issuance in an environment of higher term premiums.
When a steepening yield curve is caused by sticky long-term yields, overall borrowing costs remain high. This discourages companies from issuing new debt, and the reduced supply provides a powerful technical support that helps keep credit spreads tight, even amid macro uncertainty.
U.S.-China friction presents a dual threat to bond markets. Near-term growth risks from tariffs and domestic instability could push yields lower. Simultaneously, medium-term uncertainties from higher fiscal deficits, inflation, and AI-related spending point towards a steeper yield curve and higher long-term rates.