By mid-July, bond markets look deceptively serene. Yields have eased modestly, credit spreads are contained, and volatility is nowhere near the extremes of recent years. On the surface, investors could be forgiven for believing the worst of the turbulence has passed. But beneath this calm lie cross-currents that deserve more attention — fiscal strains, political pressures, and supply dynamics that can shape the second half of the year.
The US: front-end calm, long-end questions
In the US, ten-year Treasury yields have drifted just under 4.5%, offering an entry point that looks compelling relative to equities or cash. The front end of the curve reflects softer economic data and a market eager to price rate cuts. Yet the longer end tells a more complex story: term premia are edging higher as investors weigh rising deficits and the prospect of continued heavy issuance.
The Treasury’s funding needs are extraordinary, and while demand remains robust for now, the balance between supply and absorption is tightening. For investors, that means the “risk-free” asset is anything but costless. Owning duration today is not about predicting the next CPI print — it’s about judging whether the structural bid for Treasuries can keep up with a government borrowing requirement that now runs into the trillions.
The UK and Europe: fiscal clouds gathering
Across the Atlantic, the UK faces its own challenges. Gilt yields retreated from recent highs, but 30-year paper still trades at levels not seen since the 1990s. The shift in issuance strategy — away from ultra-long maturities, in recognition of shrinking pension demand — has helped cap the pressure. Yet the fiscal arithmetic remains difficult. Net borrowing is running at levels that leave little headroom for Chancellor Reeves ahead of the autumn budget. With debt-to-GDP pushing above 95%, any disappointment on growth or revenue could leave the gilt market vulnerable.
On the continent, Europe’s funding calendar is daunting. The EU’s €98bn 30-year syndication in July drew heavy demand, but the scale of issuance across member states is significant. Order books remain healthy for now, yet the risk is that after the summer lull, markets face a glut of supply just as political uncertainty in France and fiscal pressures in Italy return to the fore.
Credit markets: calm, but complacent?
Spreads in both investment grade and high yield credit remain tight, supported by steady inflows and modest net new issuance. Fundamentals, at least at the index level, look resilient. Interest coverage is adequate, defaults remain contained, and rating agency actions are balanced. But valuations leave little margin for error.
The lesson from previous cycles is that liquidity vanishes quickly when conditions shift. New issues can still offer value when concessions are genuine, but in secondary markets, patience often proves more rewarding than reach. Investors are being paid to wait, not to chase.
Policy and politics: the harder part to price
Central banks are closer to neutral than to extremes. Inflation is moderating, but not consistently enough to allow aggressive easing. Markets are still willing to believe in the dovish path, yet policymakers are constrained — not only by the data, but by politics. In the US, pressure on the Federal Reserve from the White House is unusually explicit. In Europe, governments are under strain to finance spending commitments without spooking bond markets.
This is the essence of fiscal dominance: when debt sustainability begins to shape monetary policy, not the other way round. Whether we are at that point is open to debate, but the risk premium for such an outcome feels uncomfortably thin.
Positioning through the calm
How, then, to invest in this environment?
- Government bonds: We see value in five- to ten-year US Treasuries at current yields. They offer attractive income and scope for capital gains if growth disappoints. By contrast, European government bonds require more caution given the post-summer issuance bulge and persistent political uncertainty.
- Investment grade credit: Higher-quality issuers remain preferable. Income is adequate, fundamentals are stable, and spreads, while tight, still offer compensation in relative terms. Selectivity is key.
- High yield: Valuations look stretched. Fundamentals are not yet flashing red, but liquidity is thin, and technical support could fade quickly if sentiment turns. This is a part of the market where patience and discipline matter more than ever.
Final thought
July’s calm surface should not lull investors into complacency. Bond markets appear stable, but they are absorbing fiscal and political risks that cannot be dismissed. Issuance is heavy, policy is contested, and valuations leave little cushion. For long-term investors, that makes it a time not for bold prediction, but for careful preparation.
At Cavalen, our conviction rests not on forecasting every data point, but on recognising when markets are underpricing risk. The calm before the issuance storm is precisely such a moment.
Craig Veysey, Chief Investment Officer