At the half-year mark, bond markets have clearly entered a new regime. While the expectations formulated at the end of last year remain broadly valid, the environment has proven more challenging than initially anticipated. More persistent inflation, elevated issuance volumes, and shifting monetary policy expectations have all contributed to a repricing of interest rates.
Against this backdrop, the asset class remains attractive, but the performance drivers are evolving. Spread compression, which was the dominant source of returns in recent years, is gradually giving way to a carry-driven environment, where selectivity is once again becoming a key differentiator.
Rates: Higher Levels Driven by Inflation and Heavy Issuance
The most notable development of the first half of 2026 has been the rise in interest rates, which are now settled at levels above those anticipated at the beginning of the year. In the euro area, the 10-year Bund is currently trading around 3.0%, compared with an initial year-end 2026 estimate of approximately 2.8%. This adjustment primarily reflects more persistent inflation. The energy shock from the beginning of the year—though already partially mitigated by oil prices falling back below $75 a barrel—has only been partially absorbed into inflation expectations, suggesting a lasting spread of pressures throughout the economy.
In response, the European Central Bank has slightly revised its policy trajectory. Whereas markets had initially anticipated a prolonged period of stable rates, they are now pricing in one to two additional rate hikes before rates eventually stabilize. This shift has helped anchor medium-term inflation expectations while also contributing to a significant normalization of market volatility following the 2022 to 2024 period.
In the United States, the picture is similar, although uncertainty remains higher. The 10-year Treasury yield, originally projected at 4.3% by the end of 2026, could instead settle closer to 4.5% in a stable environment. This outlook reflects the combination of a large public deficit and Federal Reserve communications that investors now view as less predictable, creating the potential for more persistent volatility.
Another major factor shaping rates markets is the supply dynamic. In the euro area, gross sovereign issuance is expected to reach around €1.45 trillion this year, with nearly 40% of annual issuance still to come as of mid-year. As of mid-June, Germany still needed to raise approximately €170 billion, while France and Italy had around €140 billion and €150 billion, respectively, left to issue. This heavy supply, combined with reduced central bank participation, continues to exert upward pressure on long-term yields.
In this environment, sovereign spreads appear broadly normalized. As of mid-June, French and Italian spreads versus Germany stood at approximately 64 and 70 basis points, respectively, leaving limited room for further tightening. Nevertheless, absolute yield levels remain supportive of investor demand, with peripheral sovereign debt offering yields between 3.4% and 3.9%. Spain continues to stand out for its resilience, while France remains under closer scrutiny. Ongoing budgetary and political uncertainties could push its spread to as much as 80 basis points by year-end.
Emerging market debt also fits squarely within this search-for-yield environment. Yields are currently around 7% on hard-currency debt and can reach significantly higher levels in local-currency markets, in some cases approaching 15%, as seen in Brazil. Investor flows remain positive, supported by improving fundamentals and the diversification benefits that emerging debt brings to fixed-income portfolios.
Credit: Tight Spreads but Carry Back at Center Stage
Credit markets are currently characterized by a somewhat paradoxical situation. On the one hand, spreads remain close to historical lows, reflecting rich valuations and offering limited potential for further compression. On the other hand, inflows into the asset class remain strong, supported by the return of yield levels that investors once again find attractive. Within the Investment Grade segment, current yields range roughly between 3.5% and 5% for Euro IG and US IG markets, while riskier segments, as expected, continue to offer higher yields.
This shift has fundamentally changed investor behavior. The prevailing approach is now one of carry investing, with investors increasingly adopting a “yield buyer” mindset, where income generation takes precedence over relative valuation considerations.
This trend is reinforced by generally healthy corporate fundamentals. Expected default rates remain around 2% to 3%, below historical averages, helping justify tight spreads despite a more uncertain macroeconomic backdrop.
At the same time, the market’s absorption capacity remains strong. Although issuance volumes have been substantial—including several large corporate transactions—new supply has generally been well absorbed, demonstrating the depth of investor demand. This is particularly evident in shorter maturities, where investors are seeking an attractive balance between yield and interest-rate risk.
Within the credit universe, certain segments continue to stand out. Hybrid and subordinated bonds still offer an appealing yield premium, supporting their popularity among investors. By contrast, the highest-rated securities appear more constrained, with very limited room for further spread tightening.
Conclusion: The End of the “All-Spread” Era, the Return of Carry
Bond markets are entering a more mature phase, characterized by higher interest rates and abundant issuance. In this new environment, performance drivers are changing: spread compression is giving way to a carry-focused investment framework in which yield becomes the primary source of returns.
This shift does not call into question the appeal of the asset class—quite the contrary. Current rate levels—around 3% in the euro area and 4.5% in the United States— offer a yield base that has become attractive once again. However, it now requires a more selective approach, taking into account the growing divergences among issuers and market segments, while remaining mindful of elevated valuations in areas such as artificial intelligence-related assets and the U.S. private credit market.
More than ever, performance in fixed income depends on the ability to balance rates, credit and diversification with precision. Opportunities remain abundant, but in today’s market they are increasingly driven by careful selection rather than broad market trends.
*Source: Ostrum Asset Management, June 2026. The analyses and opinions expressed in this document represent the views of the authors cited. They are stated as of the date indicated, may change without notice, and should not be interpreted as having any contractual value.