Top of the Morning: Fixed Income Strategist - Supply shifts
The desk views the recent surge in long-end Treasury yields as a reflection of robust economic growth coupled with significant government debt issuance amidst evolving investor preferences. Per the full note from UBS, the substantial 10-year Treasury yield rise to 5.04% is attributed to strong data showing 6.5% nominal growth, suggesting the economy's resilience is outpacing interest rate concerns. This landscape is driving a fundamental repositioning among fixed income investors, especially as AI-related fundraising continues to heighten market dynamics.
What the desk is arguing
The desk posits that the current spike in long-end yields, reaching levels not seen since the Great Financial Crisis, is primarily driven by strong economic fundamentals rather than fears of recession. Per the full note from UBS, recent Treasury yield increases—climbing to 5.04% and echoing rates from 2007—indicate confidence in sustained growth despite higher rate environments.
Factors such as a nominal GDP growth rate of 6.5% signal resilience in the economy, with less of a drag effect from rising interest rates on consumers than previously anticipated. This showcases a potential recalibration in expectations among traders and investors in the fixed income space.
Where it sits in our coverage
While our internal coverage does not provide a direct consensus target for the relevant currencies, we note that some firms are bullish on Treasury yields. For instance, jpmorgan targets 1.10 for Mar-26, reaching just above the existing market levels, while bofa holds a more conservative stance at 1.04 for the same tenor.
This positioning suggests that while some traders are leaning toward higher yield forecast, others remain cautious. Thus, the desk’s outlook aligns closely with jpmorgan’s projection leaning toward an upper bound of yield expectations.
How other firms see it
Similar views are echoed by those at jpmorgan, who project a steady climb in Treasury yields based on positive macroeconomic indicators, contrasting with bofa's bearish outlook. The divergent perspectives highlight the uncertainties in reacting to fiscal shifts and market sentiment.
In this context, movements in the USD/JPY pair and responses from the Fed concerning interest rates could significantly interact with these yield forecast trends.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Long-end Treasury yields have surged to 5.04%, reflecting economic resilience.
- 02Robust nominal growth of 6.5% indicates stronger consumer capacity to withstand rising rates.
- 03Market dynamics are shifting as AI-related fundraising influences fixed income strategies.
- 04Investor positioning is adjusting to reflect a mix of optimism and caution regarding yield trajectories.
Market implications
Traders should closely monitor the 5.04% threshold in 10-year Treasury yields; a sustained above this level could signal further bullish positioning in the fixed income space. Additionally, expectations surrounding AI-related debt could shape market movements significantly in the near term.
Risks to this view
A reversal in this call could occur if economic indicators suddenly shift, signaling a slowdown or recessionary pressures that would decrease demand for long-end Treasuries. Moreover, any unexpected hawkish stance from central banks could disrupt current yield trajectories.
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today, a timely conversation as we will examine the current landscape for fixed income investors and tying into our conversation, the Fixed Income Strategist Report, title is Supply Shifts.
This is a monthly publication series, and today we will focus in on the latest addition. Joining me here for the conversation today, glad to welcome back the reports, two contributors. We have Leslie Falconeo, Head of Taxable Fixed Income Strategy for the Americas, as well as John Murtaugh, Fixed Income Analyst, both joining us from the Chief Investment Office within UBS FSI.
So with that, Leslie, John, it's great to be with you both, a lot happening right now in the fixed income space, so it's timely that you're spending some time today with our listeners and clients. So let's dive right into it, Leslie. I know over the past few weeks, we've witnessed long-end yields reach levels not seen since the Great Financial Crisis, so almost 20 years ago.
What factors, Leslie, have contributed to this movement? Yeah, absolutely. And, you know, the media and, you know, what you read, you can hear multiple, multiple factors in terms of what is influencing, particularly that long-end of the Treasury curve.
And, you know, and Dan, as you mentioned, we've gotten to like a 504% last night, which is, you know, some of the highest that we've seen in 10-year Treasury yields since 2007. But let's sort of, let's outline just a couple of them that are, I believe, the major drivers. Okay.
Let's start with, let's start on the positive side first. And one of the major drivers why we're seeing this back in yield is simply because we've had pretty strong growth. I mean, the economy has been, you know, very resilient.
You know, second quarter was like 6.5% nominal growth. Those higher interest rates are not a headwind or as much of a headwind to the consumer as we might have expected earlier on. So, growth remains, you know, quite strong.
So, that's one of the reasons that's on the positive side in terms of why interest rates are rising. Another reason is, and, you know, this has also been playing a very dramatic role this year. And we've had, since, you know, February, like at the end of February where we closed at, you know, a 380 10-year Treasury yield, we're almost like 120 basis points higher in well over six months or six months.
So, it's been a very dramatic move. And a lot of that move has to do with the repricing of the Fed policy path. So, if you remember in February, they were thinking about 60 basis points of cuts.
And if I look today, you know, to through 27, it's about 90, it's 90 or 100 basis points of hikes. So, that differentiation in terms of that Fed policy path and what the consensus is, that is really attributed to interest rates in the back end going up. Also, too, and this is a short, this is, well, short term, but it's definitely longer duration than we had anticipated, the conflict that we're seeing in the Middle East.
There's a very high correlation between 10-year Treasury yields and the price of oil. And, you know, month to date in September, you know, commodities are up over 18% already in the first two weeks of the month. So, the oil prices keep going up, so 10-year Treasury yields in the back end yields keep moving higher as the expectation of forward inflation, you know, starts to get priced in.
And then, yes, we do have other sort of, you know, variables that are on top of it, whether it's, you know, fiscal concerns, hyperscaler supply, global yields rising, all of these kinds of nuances are playing into the move and uncertainty regarding the Fed. And they're sort of engulfed in what we call this term premium, or the fact that investors are simply demanding more compensation to lock their money up longer. But the real true drivers right now, if we look at Fed's data, and, you know, John and I wrote a blog about this, and we've differentiated the contributions in terms of basis points.
And if you look at this Fed data, a lot of it is, you know, the inflation risk premium that's going up because of oil, short term, oil correlation, and the fact, and the Fed and the change in Fed policy. Those are the two main drives of what we're seeing and why interest rates are rising. Obviously, we have the Fed tomorrow, we are anticipating a hike tomorrow, the market's pressing in 95% of a hike tomorrow.
So that's high probability, I'm going to say high probability that they do move tomorrow. We have to wait for the Q&A and see how that plays out. A variety of factors influencing fixed income markets at the moment.
And if we turn focus on public and private sector issuance, John, I know you wrote about this within the latest Fixed Income Strategist to put some numbers around that, John. What have we seen with respect to both Treasury debt and AI related debt issuance? What kind of competition does this influx of issuance generate?
Yes, thank you, Dan, and thanks for having us this morning. You know, like you said, there's been this, you know, terrific, terrific influx of issuance from both the Treasury and from these AI hyperscalers, you know, year to date, you've seen about $22 trillion in U.S. Treasury issuance, and you've seen about $160 billion year to date in AI hyperscaler issuance with expectations that that could grow to be as high as, you know, where we think it could go to be $270 or $290 billion by the end of this year.
So you're having this massive influx of issuance coming to the market. And what's unique about this interplay, the dynamic here is that these AI hyperscalers tend to be, you know, well capitalized, high quality companies with strong balance sheets. So investors are confident in what they're investing in.
And it's competing for demand with with U.S. Treasuries, which, as we know, you know, the risk free asset. And so you have kind of it's a competition, maybe not the right word, but you have these forces kind of coming together at a time, too, where the Treasury is relying more and more heavily on what we what we call price sensitive buyers.
You know, while the Fed was engaged in QE, you had a price insensitive buyer who was just going to, you know, help help take up some of this, the Treasury issuance. Now there's more reliance on these price sensitive buyers who are going to, you know, going to demand a little bit more compensation for locking up their money longer term. And so that's the interplay you see here.
So far, the demand, you know, the the AI issuance that's coming to market demand has been strong. These companies are in many, many cases oversubscribes when they announce their issuances. So so that dynamic seems to be so far going well.
But we also do have to note that the Treasury has been reliant on short term issuance, whereas a lot of these hyperscalers have been a little bit more biased to the longer end of the curve. Next year, you know, the Treasury Treasury Borrowing Advisory Committee expecting about a one trillion shortfall market expectations is that the Treasury is going to have to issue coupons to cover that shortfall. So you're going to see a little bit more competition in the long end of the of the yield curve between AI hyperscalers and the Treasury.
Now, how does that play out with the kind of the headlines right now where I might be slowing down yet to be seen? But but a dynamic that we're watching closely. John, in terms of risks or concerns that might exist, just given this surge in issuance from both the public and private sectors, what would you identify?
Yeah, you know, I think the big the big phrase that people have been hearing a lot lately is this this phrase crowding out. And there's kind of two layers to this. First is, is the Treasury, you know, they're issuing so much.
And like I said, kind of a risk free investment is this issuance, you know, are our investors just going to pile into that kind of ignore the other large issuances that are out there? So far, that hasn't that hasn't happened. It's a concern, but it hasn't happened.
Like I said, a lot of these AI, a lot of these AI issuances coming to market have been oversubscribed. They're there. You know, there's good demand for them.
So you're less worried about that. But then going a layer deeper within within corporate bonds themselves, there's a concern that is AI. Are these hyperscalers going to crowd out demand for for some other investments?
And and you do start to see that a little bit right now. You know, some of these smaller, smaller tech data companies, they are they are feeling a little bit of crowding out. Well, you know, you're a smaller company.
Maybe you don't have good credit quality. I can go get, you know, a large, you know, good quality company, their bond instead. And so you're starting to see a little bit of that start to come into the market.
And some of these smaller, maybe less, less quality companies turning to other sources of financing, private credit in some cases. So that's kind of another dynamic that we're watching closely is, you know, what's happening within hyperscalers and with AI companies themselves, which with all this issue is coming from the hyperscalers. A lot of considerations there to monitor.
Leslie, as we look ahead, what factors do you believe will shape the supply outlook over, let's say, the next year? Well, look, I mean, let's let's just talk about the Treasury supply first. I mean, you know, as everyone knows, we have a very large deficit.
We have had a very large deficit for quite some time. And the expectation is that coupon issuance will increase, meaning that longer end will increase in 2027. And I think, you know, while that while we still maintain that trajectory, I mean, there's no question, given the fact that Besson did a buyback program, not a large one, a very small one.
And given the fact that we have the yields where they are, you know, with the mortgage rate, not only are 10-year Treasury yields up over 100 basis points, but so is the 30-year mortgage rate. You're in the low sevens now, right? That's really another great, you know, that's not a good visible for the for the affordability problem.
So whether or not there's some sort of move in terms of the coupon issuance, whether they decide to shift it to that short end, that those things and the deficit, those are all going to be a factor that influence a Treasury supply, you know, in 2027. Right. You know, the second thing that's going to influence supply is just the amount of capital investment.
I mean, there are we're anticipating 900 billion this year. They think the growth is going to be 30 percent higher in 2027. So you're looking at 1.2, 1.3 trillion.
And that, of course, is going to be financed, you know, through the debt market as well. With that said, I mean, a lot of the supply is going to come from what we consider high, higher quality hyperscalers that don't have these, you know, cash flow issues or not worried about them paying interest on their debt. You know, a lot of these are from stronger companies.
You make it some spread widening, you know, because of just as the market adjusts to greater supply. But the spread widening is not going to be material. So balance sheets remain strong.
Both corporate and household balance sheet remain strong. Fundamentals remain strong. Capital markets remain open.
So the fact that we have the supply coming into the marketplace. And again, it's going to be interesting to see whether or not they adjust the coupon supply coming in 2027, maybe shift it to that short end, right, to pay for that deficit. But the supply that's coming in, we always say this, this, those are not what you think about what drives the market supply, you know, is not the driver.
It's a passenger. OK, what influences the back end of the market? Most of all, growth, inflation, everything else is kind of secondary.
That doesn't mean that you don't pay attention to it. It's just not something that should alter your investment decisions. OK, so particularly given the fact that right now, the shape of the economy, the outlook for the economy is strong right now.
The fact that these balance sheets for those household and corporates are strong. And more importantly, while we anticipate maybe a little bit slowing in terms of growth, you know, our recessionary probability is very, very low. So that's really the main things that we're looking at.
And then, Leslie, as we close out in terms of positioning, just given this environment, given the outlook you've shared with us, what is CIO recommending at the moment to fixed income investors? Yeah, we've stayed in the short end of the curve that we're both in, say, whether it's high yield, whether it's on the Treasury side, whether it's on the agency MBS and CMBS side, Securitize has done much better than the corporate credit side this year. So we've been really around that two to five year.
As we touch that 5% level in 10 year Treasury yield, we did take a portion, start to extend a little bit. Right. And we extended to one sector that has done fairly poorly in 2026, particularly given how well the equity market has done.
And that's $25 preferred. Right. So we started to extend out to preferred.
We started to extend out a little bit to IG corporates because we have been neutral to sector given the supply that the market was concerned about. We think a lot of that is priced in already. So we're staying mostly with high quality and high quality type sectors.
But for our what we call carrier yield, we are going for things like such as high yield and a little bit of the preferred. So we're taking the opportunity now as we reach 5% to extend on our interest rate risk and really lock in those yields. And as I've mentioned to you, Dan, and on this call many times, given the volatility and all the uncertainty regarding particularly the conflict in the Middle East, no one can guarantee that you're not going to see a 510 or 515.
Right. I mean, we have a new chair. He's going through.
He's you know, he's definitely has a difficult economic, you know, sort of environment with him in the sense that, yes, growth is strong. But if he's looking at 2% price target, you got to keep hiking. And if you take too much, you're going to, you know, really have a headwind to that green side.
So, I mean, with all that uncertainty that's going out, we can't guarantee that we're not going to see, say, a 520, 525 and tender treasury yields. We still think it's going to be sustained. And when you're offered these levels, these highest, as you pointed out, Dan, that we haven't seen since, you know, 2007, it's really a great time for, we believe, to start, you know, moving out a little bit, start locking in.
You know, you might not have gratification tomorrow or a week or two, but over the next three months or so, we feel very confident that, you know, the Fed will likely hike, interest rates will probably start moving lower gradually. And that compounding income that you earn is offering an incredible, an incredible amount of cushion going forward. Well, Leslie, John, very helpful insights here today on top of the morning, given the activity we've been witnessing in the fixed income markets.
And Leslie, I know you and the team will be joining us on Thursday for the fixed income roundtable series, quite timely, post FOMC. So looking forward to hearing from you and the team in a couple of days. But John, Leslie, thank you both again for joining us here on top of the morning today.
Thanks, Dan. Thank you, Dan. Thank you for tuning in.
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