Bond markets seeing the forest for the trees

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 stylizes 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 maximize 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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