Real Rates Take the Lead

The striking feature was where the adjustment came from: real yields rather than inflation expectations. Credit then repriced broadly in order of quality, with investment grade proving relatively resilient while the weakest high yield cohorts gapped wider. Volatility rose steeply in rates and only modestly in equities.

The selloff was broad and concentrated in real rates. The U.S. 2-year Treasury yield rose 55 basis points (bps) and the 10-year 53bps to 5.28%, crossing 5% for the first time since 2023 in the days before the Fed met, with the back of the curve flattening as the 5s30s spread narrowed 20bps. Crucially, 10-year real yields rose 49bps while breakevens widened only 5bps, so almost the entire move was a repricing of real rates rather than of inflation expectations, an unusual split in a month when Brent crude reached $106 a barrel. Gilts and Australian and Canadian government bonds sold off in sympathy, Italian yields rose 46bps, and only Japan was spared, where normalization was already well advanced. Euro-area spreads to Germany widened, with France the clear outlier at 42bps wider. In France, longstanding fiscal concerns were compounded by deteriorating technicals, as domestic buyers failed to step in and stop-loss activity accelerated the move, contributing to broader deleveraging across European government bonds.

Three of the four major central banks tightened. The Fed raised its target range by 25bps to 3.75%-4.00% on 16 September, its first increase since 2023, in a unanimous vote and with most participants projecting at least one further hike this year. The ECB had moved six days earlier, lifting its deposit facility rate to 2.50% and warning that the conflict in the Middle East would keep inflation above target for an extended period. The Bank of Japan followed on 18 September, raising its policy rate to 1.25% by a seven-to-two majority, the highest level since 1995. The Bank of England was the exception, holding at 3.75% by six votes to three after UK CPI rose to 3.1% in August. U.S. CPI held at 3.4% year over year with core little changed. The common thread was energy: each statement pointed to the oil shock, and none to domestic demand.

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