Economic Outlook for 4Q 2026: Anticipating Higher Yields

The geopolitical landscape is further complicating this situation. Escalating geopolitical risks and a trend towards nationalism are contributing to more frequent supply-side shocks affecting energy, trade, and critical components, thus raising the likelihood of inflation surprises that investors will seek to hedge against.

Moreover, a contraction in forward guidance from the Federal Reserve has added uncertainty about future monetary policy in the United States. Given that yields in developed markets often align with those in the US, this situation may have broader implications for G4 bond markets.

As central banks work to normalize their balance sheets, private investors—who are more responsive to valuations than the buyers prevalent during quantitative easing—are taking on a larger share of net issuance. This trend is expected to necessitate higher yields to attract investment.

Investors should note several practical implications. Managing duration risk will require closer attention, as movements driven by term premiums may be less predictable than in previous years. There is also a compelling case for diversifying curve positioning and enhancing inflation-protection strategies within fixed-income allocations, as volatility driven by supply and demand dynamics is likely to persist.

The core scenario anticipates a reflationary environment supported by strong growth and sustained momentum in AI, despite rising interest rates. While we hold a positive outlook on risk assets in the medium term due to robust fundamentals, the short-term outlook contains fewer opportunities and heightened risks. Ongoing tensions in the Middle East, increased inflation risks, upcoming elections, and fiscal pressures are all contributing to rising bond yields.

In our main outlook, we expect energy flows from the Middle East to stabilize towards pre-war levels over the coming months, alleviating supply-side price pressures. Global growth is projected to remain resilient as inflation gradually aligns with targets, allowing central banks to tighten monetary policy only modestly. Continued investment in AI and resulting productivity gains are expected to solidify earnings and risk appetite, which should create a favorable environment for risk assets.

Key implications include a strong stance on emerging market equities driven by sustained AI capital expenditures, shifting focus from large-cap tech companies to US small caps to benefit from US growth while achieving greater portfolio diversification. In fixed income, yield curves are likely to remain under pressure from both ends, with cautious central banks keeping short-term yields low while expansionary fiscal policies sustain higher long-term yields. Within alternatives, increasing exposure to hedge funds and private credit could mitigate drawdown risks as stock and bond market volatility rises.

In a scenario where inflation unexpectedly accelerates, the ramifications from energy crises may push inflation higher for an extended period, prompting central banks to tighten policies aggressively. This could lead to a weakening of global growth amid stricter financial conditions, adversely affecting risk sentiment and leading to higher real yields and underperformance in growth-sensitive assets.

In such a volatile environment, traditional hedges may become less effective as sustained inflation, slowing growth, and rising rates expose portfolios to potential losses. A focus on short-duration fixed income may reduce interest rate sensitivity, while equities with high dividend yields could become increasingly attractive. Within risk assets, credit may exhibit greater resilience compared to equities due to its income component. As global monetary policy responses prevail, shorter-duration equity markets—such as those in Europe—could see better performance. Additionally, yield curves might experience further flattening with short-term yields rising more swiftly than long-term yields as inflation risks increase.