View From The Top: Yielding to the inevitable

View from the very top: too much debt and not enough growth. This fundamental issue, with ramifications for investors in all asset classes, needs to be addressed. Rising bond yields are a problem, and so do not underestimate policymakers’ willingness to intervene in financial markets. Effective yield curve control could help reduce near-term upward pressure on bond yields and boost investor sentiment. A weaker currency may also be supportive to economic growth. These narratives can, in turn, keep corporate earnings momentum going. But the debt problem remains. Fiscal dominance is on its way. It may only be a matter of time before fiscal policy serves to dictate monetary policy. Financial repression may then follow. Authorities will likely prefer to kick the metaphorical can down the road wherever possible, but investors should be already proactively positioning for such a set of potential outcomes. Portfolio diversification is crucial, with uncorrelated and hard assets likely to be the clearest beneficiaries.

Asset Allocation:

Equities: Earnings growth continues to sustain the bull market narrative in equities. The MSCI World Index is just 1.4% from its all-time high, despite bond market tumult. The average S&P 500 Index sector has seen at least 20% upward earnings revisions year-to-date. Even if the rate of earnings upgrades may slow from here, consensus forecasts another year of double-digit earnings growth for the market in 2027 (per Bloomberg). Market leadership may shift further away from momentum and artificial intelligence plays, with quality and sectors such as healthcare and financials potentially benefiting. Mean reversion remains a powerful force. We continue to favour truly active managers. Lower bond yields would be beneficial for equities, although the inverse also clearly holds true.

Fixed income/ Credit: The almost relentless upward move in longer-dated government bond yields has been of clear concern for investors. 10-year US Treasury debt was yielding below 4.0% in February. Yields had reached almost 4.8% by the end of August. Similar dynamics are being witnessed in many other developed nations. Market intervention may help reduce some near-term pressure, but the same fundamental challenges remain unaddressed. The shorter end of the yield curve seems currently to be the safest place, while longer duration bonds may struggle to generate real returns. Stresses in private credit (with US corporate defaults in the second quarter at record levels, according to Fitch) also deserve monitoring. Adopt limited exposure to credit.

Currencies: The US Dollar has been the clearest casualty of recent bond market action, although the Dollar Index remains above the level where it started 2026. All currencies can be subject to short-term bear markets, with Dollar weakness benefiting both the Euro and the Yen. Longer-term, we believe it is difficult to see any other currency challenging the Dollar’s status.

Gold: Our positive stance on gold has been well-documented. The precious metal is the clearest beneficiary of Dollar debasement. While Governments can clearly print more currency, gold’s supply is finite. We believe that gold remains a crucial long-term core asset and portfolio diversifier, acting as a clear hedge against government intervention in financial markets and other macro instabilities.

Alternative assets: Hard assets perform an equally important role in portfolio diversification, in our view. Not only do they offer income-generating characteristics, but they provide resilience in the face of uncertainty. It is important, however, to remain selective across this asset class, favouring quality. Our focus is centred particularly on uncorrelated strategies.

Some things are inevitable: famously, death and taxes. Also, that night turns into day, or that the law of gravity endures (the latter could also apply to investing). Even a record-breaking summer of weather had to end at some point. Readers may want to add to this list the idea that something has to give when trying to fight the bond market.

Fifteen years ago, we deployed Shakespeare’s famous line, “neither a borrower nor a lender be” when seeking to characterise the debt problems faced on both sides of the Atlantic. It has remained a concern ever since. Last year we described fiscal dominance as the new normal. Events in recent weeks lend support to this thesis. Expect further intervention by policymakers in financial markets. Financial repression may be on its way. Against this background, continue to diversify portfolios.

Sure, funny things often happen in financial markets over the summer. With many away on vacation, trading volumes are – inevitably – lower and so the magnitude of perceived problems is often exacerbated. Might there not even be any issues about which investors really need worry? Bank of America’s latest Fund Manager Survey states there is “no room for pessimists.” And given the recent strength in corporate earnings, it is hardly a surprise to see equities touching year-to-date highs. However, recent developments not only feel different, they are different.

Too much debt and not enough growth is the main problem faced by most developed economies. How long this dynamic can persist without something breaking is the crucial debate. America’s national debt (defined as all outstanding Treasury bonds, bills and notes) crossed $40tr for the first time in mid-August. For context, a decade ago, the figure was less than $20tr. Project out ten years, and the Congressional Budget Office forecasts a figure of $64tr.

Nations across the world are going through transformational change. Think of it as a trifecta of artificial intelligence, demographics and geopolitical upheaval. Each impacts government debt (albeit in different ways). Most importantly, debt is compounding at a faster rate than the economies that must service it. The interest that needs to be paid on this debt creates another problem. More government spending typically means higher interest costs (already, the third largest line item of US government expenditure), adding further to the debt burden and creating a vicious circle. Current deficit levels (and debt to GDP ratios for that matter) have rarely been seen outside recessions.

With this context, higher bond yields are a concern because they increase borrowing costs across the economy, making mortgages, business loans and government debt more expensive. This can then slow consumer spending, investment and economic growth. Something could break (remember Silicon Valley Bank?). Higher yields also raise the cost of capital and can therefore put pressure on asset valuations, particularly equities.

Treasuries also now have a competitor when companies are issuing debt to fund AI. High grade corporate credit issuance in the US will likely match Treasury issuance in 2026. The hyperscalers and other key infrastructure players have roughly doubled their credit issuance relative to a year ago, with around 80% of all AI infrastructure build currently being debt financed, according to JPMorgan. Further, there is no sign of the AI (over)build coming to an end any time soon. Consider not only NVIDIA’s recent results commentary but estimates compiled by FactSet that the hyperscalers will spend an equivalent of 3% of US GDP on capex in each of the next three years. All this new corporate debt issuance is crowding out demand for government bonds.

New Fed Chair Kevin Warsh may have added a further uncertainty premium to government bonds. The elimination of forward guidance by the Federal Reserve only naturally creates more bond market volatility. Even if investors may appreciate that Warsh is committed to lower inflation, the debate remains over exactly how the Fed will achieve this. Interest hikes are a possibility. Don’t forget, US inflation has been above target for the last five years. The most recent 3.4% print (or 3.7%, using the Fed’s preferred PCE measure) is a long way north of its 2.0% objective. Ongoing Middle Eastern disruptions remain unhelpful to the cause of lower inflation.

No surprise then that yields on US 30-year debt have reached their highest since 2007. For the UK and Japan, 30-year yields touched levels previously seen last century. In Germany, long-term government debt last yielded its current level on the cusp of the first Eurozone crisis. When it comes to new issuance, the US government last sold 30-year debt with such attractive yields in 2001. On the 10-year, it was 2007. Put simply, governments inevitably have diminished bargaining power when nations are so indebted.

Hence came the announcement in mid-August that the US Treasury would increase its buyback operations, issuing shorter dated debt to buy longer-term debt. This is a sign of an administration sensitive to rising long-term borrowing costs. The Trump administration has no desire for the upward move in Treasury yields to become disorderly, particularly with mid-term elections on the horizon. Think of the move as a very clear signalling mechanism, even if it may be too early to know whether it is fully working.

Investors should not underestimate policymakers' willingness to intervene to prevent bond yields from rising too far. By issuing more short-term bills, long-term supply falls and yields naturally follow. The Treasury could theoretically continue expanding shorter-term debt to buy longer-dated bonds, effectively suppressing bond yields at any level it wanted. This is less quantitative easing – since there are no asset purchases – and arguably a form of yield curve control, via debt swaps.

However you wish to define the policy shift in the US, ultimately the authorities’ actions may prove to be more sticking plaster than panacea. Treasury Secretary Bessent may say that he is willing to do what it takes, but fiscal sustainability matters more than rate and inflation targeting. In the near term, something must give. Any indebted economy needs to accept one of the following three outcomes: tighter policy, higher borrowing costs, or a weaker currency.

The US Dollar has been the inevitable victim of the current policy actions pursued. The logic, presumably, is that a weaker Dollar will be stimulative to the economy (even if potentially inflationary – since the cost of imports effectively goes up). Current macro indicators are certainly mixed. GDP growth may be accelerating relative to the prior quarter with manufacturing surveys highlighting the fastest pace of expansion since 2022. At the same time, though, retail sales growth and consumer confidence levels are back at levels seen at the start of 2026. Recent employment trends have also been disappointing.

The more fundamental issue remains that debt needs to be structurally lower. De facto yield curve control may alter the format of the debt outstanding but not the amount. There is a clear need to make the fiscal trajectory more sustainable. No administration seems ready to do the hard work of reducing the budget deficit. Neither cutting expenditure nor raising taxes is popular.

For us, the end game is to accept fiscal dominance and hence financial repression. When government debt and deficits become so large – as they have done – then Central Banks will be effectively forced to prioritise keeping government borrowing affordable over controlling inflation. In effect, fiscal policy dictates monetary policy. It may only be a matter of time until we see lower rates, or if not, then Central Banks purchasing government debt.

Faced with the choice, would you rather allow yields to rise – and risk a debt spiral – or suppress yields, even if this meant inflation running above rates? The (latter) choice seems clear. Investors will know about it when we reach the era of financial repression. Imagine a potential world of artificially low interest rates, a scenario where institutions may be required to hold government bonds, or where wealth transfers are somehow enforced, all in the name of reducing the real debt burden over time. Start diversifying now.

Alexander Gunz