Investment Weekly: Breaking down bonds
5 October 2026
Key takeaways
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US inflation remains high, often attributed to surging oil and computing costs, as well as the lingering impact of tariffs. However, analysis using the gross value-added deflator, a measure of inflation generated by profits, wages, and non-labour related costs, offers a different perspective. The latest acceleration in headline inflation appears to have been driven mainly by stronger profit growth.
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If cash is king, do European equities deserve the crown? The region’s stocks currently offer a 3% dividend yield, in line with their 10-year average – but roughly twice their usual premium to US stocks.
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Chefs know that double-concentrated tomato paste must be used sparingly; too much can overpower an entire dish. For multi-asset portfolios, tech mega-caps present the same risk, potentially dominating both equities and fixed income to create a problematic double exposure.
Chart of the week – Breaking down bonds
G7 bond yields have risen by roughly 1% since January, with long-dated US Treasuries and UK Gilts moving well above 5%. Three explanations compete to explain the sharp repricing.
The first is fiscal deterioration. Public debt and deficits are high across much of the developed world, while increased issuance has coincided with weaker demand. Fiscal concerns, however, don’t fully explain the move: inflation breakevens are stable and yield curves have not steepened significantly. The impact has instead been concentrated in real rates.
The second explanation is stronger economic activity. PMI data and GDP nowcasts have improved, while corporate profits, margins and risk assets remain resilient. The investment associated with AI could also support growth. But productivity data haven’t yet convincingly captured that potential, making this explanation incomplete.
The third – and most persuasive – explanation is structural: crowding out and a regime shift. Fiscal deficits and AI investment are competing for capital in a world where global savings are less mobile and more limited, with the rebalancing pushing equilibrium real rates higher. If the 2010s were the era of a global savings glut and depressed bond yields, the 2020s mark the crossing of a Rubicon. Expect more fragmented capital markets, greater regionalisation, and G7 bond markets less able to rely on the “kindness of strangers” to fund deficits.
For investors, a higher-for-longer regime could offer an opportunity to generate income from G7 bonds, with returns driven less by capital gains. At the same time, bonds’ traditional hedging characteristics could re-emerge. If inflation is anchored at 2–3%, central banks would retain the flexibility to adopt a more dovish stance in periods of macroeconomic weakness or equity-market stress – giving bonds room to rally.
Market Spotlight
Nifty revival?
Indian equities have endured a difficult 2026 so far. The first half saw one of the market’s weakest performances in recent memory, as muted foreign participation, sharply higher energy costs, and a weaker rupee weighed on returns. And while foreign flows improved over the summer, investor confidence remains fragile.
Yet, the outlook may be turning. Asia equity analysts suggest India could benefit from a broadening out of market leadership as investors diversify away from a narrow group of AI-related winners. Corporate momentum already shows signs of improvement, with revenues in the large-cap Nifty index recording their strongest growth in 10 quarters in Q2, with earnings rising about 19%, ahead of expectations.
India’s economic growth has also proved relatively resilient: GDP expanded 7.8% year-on-year in the second quarter. Policy support and robust credit growth are also cushioning the economy from external shocks.
For now, India remains under-owned by global investors. But an easing of energy prices and a steadier rupee could be catalysts for a pick-up in sentiment. Risks remain but improving fundamentals suggest this sleeping giant could yet stage a turnaround.
The value of investments and any income from them can go down as well as up and investors may not get back the amount originally invested. The level of yield is not guaranteed and may rise or fall in the future. Past performance does not predict future returns. For informational purposes only and should not be construed as a recommendation to invest in the specific company, country, product, strategy, sector, or security. Diversification does not ensure a profit or protect against loss. Any views expressed were held at the time of preparation and are subject to change without notice. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecast, projection or target. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. You cannot invest directly in an index. Source: HSBC Asset Management, Factset, Bloomberg, Macrobond. Data as at 7.30am UK time 05 October 2026.
Lens on…
Inflation – a different view
US inflation remains high, often attributed to surging oil and computing costs, as well as the lingering impact of tariffs. However, analysis using the gross value-added deflator, a measure of inflation generated by profits, wages, and non-labour related costs, offers a different perspective. The latest acceleration in headline inflation appears to have been driven mainly by stronger profit growth. This framework also helps assess the market implications of alternative inflation scenarios. In a “broadening out” scenario, stronger employment gradually increases labour costs. Yet with analysts expecting profit growth to moderate in 2027, inflation should ease, enabling the Federal Reserve to raise the fed funds rate to only 4.50%. Such an environment would be supportive of risky assets. |
However, low unemployment could fuel rapid wage growth. Companies seeking to defend margins would keep inflation sticky, triggering tighter policy, while an inability to pass on rising costs would weaken profits. This wouldn’t be good news for markets. Stronger productivity that offsets wage pressures and keeps profits strong is key to providing a longer-term boost to markets.
Europe cashing in
If cash is king, do European equities deserve the crown? The region’s stocks currently offer a 3% dividend yield, in line with their 10-year average – but roughly twice their usual premium to US stocks. Share buybacks add further support: for the first time, the net buyback yield in Europe is higher than in the US, reversing a trend of high US buybacks offsetting a relatively low dividend yield. More broadly, European firms remain cash generative, with net debt-to-equity declining since 2011. Not only that, but consensus 2026 earnings growth has been revised up materially from 12% to 23%, with double-digit growth expected next year. After two years of no growth, European earnings appear to be reaching escape velocity. Cash-based valuation provides another reason for optimism. In Europe, investors appear to be paying less for each unit of cash earned, with European indices trading at 8.5x price-over-cash EPS, while the US and world indices trade at much higher levels, close to 50-year highs. |
While European stocks face headwinds from high energy prices, and political and fiscal uncertainty, their cash earnings are improving.
Double trouble
Chefs know that double-concentrated tomato paste must be used sparingly; too much can overpower an entire dish. For multi-asset portfolios, tech mega-caps present the same risk, potentially dominating both equities and fixed income to create a problematic double exposure. Amid high debt, deficits, and a hiking Fed, allocators are supplementing Treasuries with investment grade (IG) credit. Blue-chip corporate balance sheets appear better equipped to weather tightening cycles and macro risks than indebted sovereigns. But a complication is that while Financials dominate IG's nominal weight, tech issuance has surged at the long end of the curve as hyperscalers fund AI infrastructure. Investors often view this extended duration purely as interest rate risk, but it amplifies spread volatility too. Because long-dated bonds belong to key equity benchmark drivers, a major tech repricing could mute their hedging power. |
This leaves broad credit functioning less as an independent ballast and more as an echo of equity risk. With this in mind, improved resilience requires moving away from passive benchmarks towards active selection seeking diversification outside the crowded mega-cap complex.
Past performance does not predict future returns. The level of yield is not guaranteed and may rise or fall in the future. For informational purposes only and should not be construed as a recommendation to invest in the specific country, product, strategy, sector, or security. Diversification does not ensure a profit or protect against loss. Any views expressed were held at the time of preparation and are subject to change without notice. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. You cannot invest directly in an index. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecast, projection or target. Source: HSBC Asset Management. Macrobond, Bloomberg, Refinitiv, FactSet. Data as at 7.30am UK time 05 October 2026.
Key Events and Data Releases
Last week
This week
For informational purposes only and should not be construed as a recommendation to invest in the specific country, product, strategy, sector or security. Any views expressed were held at the time of preparation and are subject to change without notice. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC accepts no liability for any failure to meet such forecast, projection or target. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. You cannot invest directly in an index. Source: HSBC Asset Management. Data as at 7.30am UK time 05 October 2026.
Market review
Global equity markets struggled amid ongoing concerns about elevated government bond yields. While short-end US Treasury yields drifted lower, long-end yields rose to multi-decade highs, driven by higher real yields. European government bonds were mixed but mostly lower, with French OAT and Italian BTP yields surging as fiscal concerns weighed on sentiment. Credit spreads also widened in the US and Europe, particularly in the high-yield segment. US equities were on course to close lower for the week, although the tech-heavy Nasdaq recorded more modest losses. Weaker sentiment also weighed on key indices in Europe and Asia. Sensex fell, alongside broad-based declines in Chinese equities and ASEAN markets. Nikkei 225 bucked the regional trend, gaining on strength in technology stocks. In FX markets, the US dollar strengthened against a basket of major currencies, while gold prices extended their losses.
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