The interest rate turnaround is taking a new direction

Government Bonds

The performance of government bonds is once again being driven primarily by inflation and monetary policy. After the past few years were initially marked by sharp interest rate hikes and subsequently by the first signs of easing, the picture has recently shifted again. In September, the European Central Bank raised its key interest rates by 25 basis points in response to renewed inflation risks. The U.S. Federal Reserve also raised its key interest rate by 25 basis points in September. Above all, higher energy prices, geopolitical uncertainties, and a continued robust economy are making it difficult for central banks to return to their inflation targets.

For government bonds, this means that yields are likely to remain at attractive levels for the time being. At the same time, uncertainty about the future path of interest rates is increasing volatility, particularly for longer maturities. U.S. Treasuries continue to offer attractive current yields and remain an important diversifier. In Europe, we favor government bonds with high credit ratings, while higher government debt and political uncertainties in individual countries must be taken into account with increasing differentiation.

Overall, government bonds remain an important anchor of stability in the portfolio. However, a balanced approach to duration continues to make sense as long as the future path of inflation and interest rates remains unclear.

Investment-Grade Corporate Bonds

In our view, investment-grade bonds remain one of the most attractive segments within the bond market. The balance sheets of many companies remain solid, and high-quality issuers are generally able to absorb the higher interest rates. At the same time, the rise in base rates enables attractive total returns without requiring investors to take on significantly higher credit risks.

However, credit spreads remain low. Investors are thus compensated primarily through the current coupon rate rather than through a further significant narrowing of spreads. At the same time, a greater differentiation between companies and sectors is emerging. Companies with high future financing needs, in particular, are being viewed increasingly critically by the market.

Investment grade therefore remains a core component of our bond portfolio. Quality, solid cash flows, and manageable debt levels are clearly the top priorities.

High Yield

In the high-yield segment, a clear distinction based on credit quality remains essential. For BB- and high-quality B-rated issuers, fundamentals remain solid in many cases and total returns are attractive. At the same time, credit spreads—particularly in the higher-quality high-yield segment—are very tight and offer only a limited buffer against an economic downturn.

The situation is markedly different for weaker debtors. In the CCC segment, risk premiums have widened noticeably recently. The market is thus beginning to distinguish more clearly between companies with sustainable business models and highly indebted issuers.

High yield therefore remains a tactical allocation for us. We continue to favor BB-rated and select B-rated issuers and avoid chasing high nominal yields at the expense of credit quality.

Emerging Market Bonds

Emerging market bonds continue to offer high nominal yields. At the same time, the environment has become more challenging due to rising interest rates in developed countries, a strong U.S. dollar, geopolitical tensions, and higher energy prices. Countries with high foreign-currency debt, in particular, remain vulnerable.

In addition, the fundamental situation varies greatly across emerging markets. While some countries have solid current accounts and sufficient foreign exchange reserves, debt sustainability remains a problem for others.

The key question, therefore, remains whether the additional yield sufficiently compensates for the higher political, currency, and credit risks. For broad-based emerging-market bonds, we continue to view this trade-off as unconvincing at present and remain cautious accordingly.

Conclusion

The bond market environment has changed compared with the previous quarter. Hopes for steadily falling interest rates have given way to renewed concerns about persistent inflation. The recent interest rate hikes by the ECB and the Fed show that the fight against inflation is not yet over.

For investors, this is not necessarily a negative development: Higher interest rates ensure that high-quality bonds continue to offer attractive current income. Government bonds and investment-grade bonds therefore remain our preferred segments and simultaneously fulfill their important role as building blocks of stability and diversification within the portfolio.

In the high-yield sector, we remain selective and focus on higher credit ratings. We continue to take a cautious view of emerging-market bonds, as the additional yield does not currently seem sufficient to us given the risks involved.

Overall, we remain constructive on high-quality bonds; however, given the renewed uncertainty surrounding inflation and interest rates, we would continue to maintain a balanced position in terms of duration.

Mimi Haas, Lic. rer.pol. HSG, M.A. in Banking and Finance HSG, Partner

_{Sources: MarketMap, Bloomberg, and DWS
As of: September 28, 2026}