Bond markets seeing the forest for the trees

By Thomas Garretson, CFA

At the halfway point of 2026, global bond markets are lagging the already low expectations we held at the start of the year. Not only have many major global bonds failed to earn their coupons, rising bond yields – which move inversely to bond prices – have pressured prices lower to such a degree that declines have more than offset coupons earned, putting total return performance modestly in the red year-to-date.

A simple explanation would be that the unexpected war in the Middle East and the subsequent jump in oil prices, along with another round of supply chain disruptions, have caused a temporary spike in inflation, central bank rate hike expectations, and bond yields. There’s a sense then that these moves could be unwound just as quickly as they appeared if/when there’s a resolution to the conflict. But we think that could be too simple, and perhaps too myopic.

While the Middle East conflict is no small issue, we do see it as just another tree in a forest of reasons that has pressured global yields higher not just this year, but for many years running at this point.

The chart below stylises just that. The gray lines represent the 30-year government bond yields of the U.S., Canada, Germany, Japan, France, and the UK. Which is which doesn’t matter, and that’s the point – nearly all are at or near 20-year highs, while the simple average yield of the group has breached 4.0 percent for the first time since early 2009.

The forest of global 30-year sovereign bond yields shows a rising trend with no signs of slowing

30Y bond yields of Canada, U.S., UK, Germany, Japan, and France

Oil prices and central bank rate hike fears are dominating the narrative at the moment, but we think markets are pricing a bigger confluence of factors as driving these trends, and these factors largely continue to point in the same direction – higher yields still.

Everything costs more, including money

So, as we take stock of the first half of 2026, and what we might expect for the rest of the year, we can’t help but feel the desire to take an even bigger step back.

The technology hyperscalers are issuing massive amounts of debt and equity to raise funds for the ongoing AI buildout. Governments, not to state the obvious, continue to issue massive amounts of debt to fund ongoing deficits, and defence costs for certain regions are only likely to compound those deficits. The demand for capital amid a global economic backdrop that remains steady is increasingly overwhelming the supply of capital, as savings rates decline and aging populations pivot from saving money to spending it.

Where might it end? We would concede that we don’t have a high-conviction view on that front. We had anticipated a return to pre-global financial crisis levels – which appears to be where we are now. A return to pre-2000 yield levels of five percent to six percent appears increasingly likely as the tech boom of today seems at least comparable to the tech boom of the 1990s, propelling near-term economic growth and inflationary pressures higher.

Central banks ready a response

For all the hyperfocus of late on central banks and the potential for rate hikes, we think any adjustments will be both modest in nature and little more than necessary recalibrations to economic realities on the ground. Single-mandate banks such as the European Central Bank (ECB) and the Bank of England (BoE), which target only price stability, will need to act sooner rather than later, while others have more time to gauge the impact on economic growth, labour markets, and inflation in their totality.

Federal Reserve and Treasury yields

• Our base case is that the Fed keeps rates on hold through 2026 and 2027, but with a bias toward rate hikes. Though markets are pricing a 100 percent chance of a rate hike this year, we would highlight that they are giving the Fed a longer runway for potential action than other central banks, as market-implied prospects don’t exceed the key level of 80 percent until the Fed’s December meeting.
• With respect to the benchmark 10-year Treasury yield, on balance we expect it to hold at current levels around 4.50 percent, but with an upward bias. Importantly, we do see scope for it to test key technical levels of this cycle: 4.80 percent in 2025 and 5.0 percent from 2023.

European Central Bank and German Bund yields

• The ECB was the first G7 central bank to raise rates this year at its June 11 meeting, and we see two more 25 basis point rate hikes in the pipeline this year before the ECB likely holds at a policy rate of 2.75 percent into 2027.
• The German Bund yield broke above 3.0 percent following the onset of the Middle East conflict and has largely held that level since. Our forecast has it rising modestly toward 3.25 percent this year, and to 3.40 percent in 2027.

Bank of England & Gilt yields

• After the ECB, we think the BoE will likely be the next to act with a singular rate hike at its September meeting to 4.0 percent before pausing through 2027.
• Despite a modest BoE rate outlook, the 10-year Gilt yield has been highly volatile this year, trading as low as 4.2 percent and as high as 5.2 percent. For now, we see it steadying around 5.0 percent through year-end.

Bank of Canada and Government of Canada yields

• The Bank of Canada (BoC) is stuck between weak economic growth and rising price pressures. But like the Fed, we think the BoC will remain on hold this year, with potential hikes in early 2027.
• The benchmark 10-year Government of Canada yield has averaged 3.4 percent over the past year, is currently trading around 3.5 percent, and we see it only rising toward 3.6 percent by year-end.

Current RBC central bank rate projections

Chopping wood

While bond markets focus on the forest of interest rate dynamics, individual bond investors need to know which trees to chop down for yield. Despite rising yields, and to what are certainly historically attractive levels, we still expect a somewhat challenging landscape for bond investors. Given that we see little scope for sovereign bond yields to move materially lower absent economic downturns, investors should simply aim to maximise income, as bond price appreciation on top of coupons could remain elusive.

Global corporate bonds present just 0.76 percent of incremental yield over their government bond peers for potential credit and default risks. While not quite as low as the lowest lows of 2005 (+0.55 percent), the margin for error is clearly miniscule.

Global corporate bonds offer plenty of yield, but little excess yield for potential credit risks

Therefore, we hold a cautious outlook on credit, but absent a recession the asset class should perform reasonably well, and at the end of the day, extra yield is extra yield. There’s also the not-so-tongue-in-cheek idea that corporate balance sheets might look healthier than government balance sheets.

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