Bond yields should fall despite near-term volatility

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Global bond yields have risen to their highest level in a month after renewed strikes in the Middle East pushed up oil prices. Minutes from the Federal Open Market Committee’s June meeting that showed growing inflation concerns also intensified investor worries over tighter central bank policies. Specifically, “a few” participants said there was a case for raising rates last month, and that “some policy firming would likely be warranted” if inflation remains elevated.

The 10-year US Treasury yield was trading near 4.57% at the time of writing, and the 10-year German Bund yield stood around 3.07%. But we continue to expect bond yields to fall as the year progresses and believe that current elevated yields offer an opportunity to secure appealing portfolio income.

Oil prices should stay below wartime highs. The latest exchange of attacks underscores the challenge in finding lasting peace between the two adversaries, but we also believe both the US and Iran have strong incentives to avoid a return to all-out war. Given that both the return of shipping confidence and the recovery of production will likely take time, we expect Brent crude oil prices to end the year higher at USD 85/bbl. But this level remains well below the USD 120/bbl seen at the height of the conflict, and we expect limited pass-through to core inflation.

Inflation should moderate in the coming months. Preliminary data showed that Eurozone inflation cooled in June, and we expect to see a similar pattern in the US as tariff effects prove disinflationary during the second half of this year. Fed Chair Kevin Warsh and European Central Bank President Christine Lagarde have both recently acknowledged that inflation pressures have eased, and consumers’ inflation expectations remain anchored. While AI-driven demand should support prices, we expect a gradual resumption of traffic through the Strait of Hormuz to alleviate energy supply bottlenecks and ease inflation concerns.

Current market pricing of central bank policies remains too hawkish, in our view. Central bank officials are likely to maintain their hawkish stance in the near term, but we expect the rhetoric to soften once they become more confident that second-round inflation effects are limited. With the Fed reassessing its framework and tools for policymaking, we maintain the view that the bar for a Fed hike is high. We also do not see an aggressive tightening cycle ahead for the ECB given the current data and energy backdrop.

So, while yield volatility may stay elevated in the near term, we view the recent sell-off in global bond markets as an opportunity for investors to lock in attractive yields. We favor short- to intermediate-maturity quality bonds denominated in US dollars and British pounds, and see value in select European bonds with longer maturities.