By Kellie Wood, head of fixed income, Schroders
With yields above 5% and central banks tightening into an oil shock, high-quality bonds are once again offering what investors need most: strong income and real protection if growth falters.
For the first time in years, bonds are looking like they are well placed to do their job again. With 10-year yields above 5% in both Australia and the US, government bonds now offer serious income and potential diversification if growth stumbles.
That hedge matters more than ever. Equity markets are crowded into a single AI trade, and any disappointment in earnings, capex returns or adoption could hit hard. Bonds at these levels offer the protection that simply wasn’t there when yields were near zero.
The macro case is building fast. Markets are pricing around 100bp of further tightening across most developed economies. If central banks deliver it, growth will slow, and the risk of a policy mistake is rising. Central banks are tightening into an oil supply shock, yet pass-through to underlying inflation remains limited.
Australia’s August CPI says it all: headline inflation jumped to 4.0%, but trimmed mean slowed to just 0.2% for the month, below the 0.3% expected, with fuel and electricity driving the gap. Hiking rates to fight a supply shock that isn’t feeding through to core inflation risks deepening the slowdown and bringing the next easing cycle forward. The US is the exception, where strong growth gives the US Federal Reserve (Fed) room to keep going. That divergence sits at the heart of our positioning.
Australian rates: The Hike Is Done. The Cut Is Coming.
With markets pricing a peak near 5.15%, we think the tightening cycle is fully priced. Our cash rate model peaked at 4.75% and is already turning lower as housing, jobs and sentiment weaken. August CPI backs this up, with headline inflation driven by fuel and electricity while underlying inflation has stalled at 3.6%. The September jobs data and September CPI will be important ahead of the November meeting. As the inflation shock matures, we expect the story to flip from inflation to growth, with the RBA cutting in 2027.
Global rates: synchronised tightening, synchronised risk
The Fed, ECB and BOJ all hiked in September, a rare moment of global hawkishness in response to an energy shock. Even Warsh acknowledged that tightening abroad could help cool global inflation and limit the need for more Fed hikes. That’s the dynamic to watch into year-end: coordinated tightening against a supply shock raises the odds of a sharper global slowdown. Oil remains the wildcard. A breakthrough on Hormuz could reprice curves overnight, while escalation would push inflation expectations higher everywhere.
Global credit: the adjustment has begun
This wasn’t a full risk-off move, but the direction is clear. Higher yields and heavy supply are challenging rich valuations, and US high yield is feeling it first. With weaker borrowers facing a tougher refinancing wall, we favour quality carry overreaching for yield.
Australian credit: resilient, but pick your spots
Australian investment grade remains well supported by demand for high-quality financials, but restrictive rates demand discipline. We favour defensive real assets sectors such as infrastructure and utilities and are wary of sectors exposed to a fading consumer. The silver lining: softer spending could ease inflation and rate pressure, reinforcing our view that the RBA’s next move is a cut.
