Income opportunity as bond yields edge up

Markets react to inflation worries, uncertainty over Fed’s response

Oil prices are swinging with every twist in the Middle East conflict, while AI earnings and spending plans are driving sharp moves in stocks. Alongside the repricing in government bond yields, these developments underscore our long-held view of a world shaped by supply scarcity keeping inflation and borrowing costs higher. For investors, the role of government bonds has shifted: less ballast, more income.

The steepening of the two-year/30-year Treasury yield curve after July’s Federal Reserve meeting reflects growing inflation worries and uncertainty over how the Fed will respond. We see this not as new but as a continuation of the broader macro regime we have described for several years.

The fastest AI investment buildout in history is unfolding in a world shaped by supply scarcity, where energy constraints, tight labor markets, and geopolitical fragmentation are shifting the focus from efficiency to resilience. Meanwhile, governments and hyperscalers are drawing on the same pool of savings, intensifying competition for capital. These forces are pushing investors to demand higher returns to lend for longer, lifting real yields across developed markets (see the chart below). That broader repricing underpins today’s investment backdrop.

The global repricing of long-term bond yields has come a long way. The U.S. 10-year Treasury yield has risen from less than 1% six years ago to nearly 5% today. German 10-year yields recently reached a 15-year high, and Japanese 10-year yields have approached 3% for the first time since the mid-1990s.

The structural forces behind higher bond yields have been building for several years but intensified this year. What was already the fastest AI investment boom in history has accelerated further, with consensus forecasts for hyperscaler capital spending in 2026 revised about 30% higher over the past six months to $720 billion. Greater sovereign borrowing and persistent fiscal deficits, alongside a shift in Middle Eastern investment toward domestic priorities, have reduced capital available for overseas investment and further intensified competition for capital.

Sharp repricing of Fed expections

Scarcity-driven inflation – amplified by the Middle East energy and commodity shock – has driven a sharp repricing of Fed expectations from easing to tightening, prompting a global rise in bond yields. More recently, new uncertainty around the Fed’s reaction function under new Chair Kevin Warsh has pushed the term premium higher.

Higher yields have changed both the role of government bonds in portfolios and the opportunity set for investors. Bonds have become a less effective portfolio ballast. The correlation between daily U.S. equity and 10-year Treasury returns averaged 7% over the last five years, compared with -43% in the decade prior to the pandemic.

Investment implications

Still, higher yields have created attractive income opportunities, reinforcing our durable income theme. More than 80% of the global bond universe now yields above 4%, versus around 20% in the decade pre-pandemic.

Rather than reaching further out the curve, we favor building durable income through short- and medium-term Treasuries, local-currency emerging market debt, short-maturity euro area bonds, agency mortgage-backed securities and selected public and private credit with resilient cash flows.

Higher borrowing costs also raise the bar for equities. But companies able to grow earnings faster than borrowing costs increase can still outperform. However, we expect greater dispersion across companies, strengthening the case for active investing.

Bottom line

AI investment, prolonged supply shocks, and heavy government borrowing are accelerating the repricing of long-term rates. Government bonds provide less ballast but more income, expanding the opportunity for durable income.

Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.

Wei Li, Managing Director and Global Chief Investment Strategist at BlackRock Investment Institute, Ehsan Khoman, Economist – BlackRock Investment Institute, and Michel Dilmanian, Portfolio Strategist – BlackRock Investment Institute, contributed to this article.

Disclaimer

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