- Significant recent bond issuance has tested investor appetite, while macro and geopolitical uncertainty poses a further challenge.
- The case for fixed income remains strong given the attractive real yields available and downside mitigation properties the asset class offers.
- Global government bonds can give portfolio constructors a way to smooth the idiosyncratic risk of any single market, while also providing low correlation to major equity markets.
1. Surging bond issuance meets shifting demand
In early September, we saw a surge in global bond issuance in both Europe and the US1. This wave of supply, typical for the period after “Labor Day” in the US (which takes place on the first Monday of September), has been met with strong investor interest, as evidenced by oversubscription rates ranging from two to fifteen times. Yet, despite this demand, yields have continued to rise, highlighting a complex interplay between supply and appetite for risk.
This paradoxical environment reflects both robust demand and emerging fatigue among fixed income investors. While new issues are being absorbed, the sheer volume is testing the market’s capacity, especially as investors weigh the implications of higher yields and the potential for further supply. The result is a market in flux, with price discovery and risk premia adjusting in real time.
For investors, this dynamic underscores the delicate balance between supply and demand, as shifts in investor sentiment or funding conditions can quickly alter the landscape.
2. US macro resilience and the Fed’s policy dilemma
The US economy has continued to defy expectations, with Q2 GDP revised upward to 3.3% and Q3 projections similarly above trend at around 1.6%, according to a Bloomberg forecast2. This strength is mirrored in the US labour market, where wage growth and stable employment have fuelled services-driven inflation. Inflation remains anchored near 3%, a level that historically would prompt the Federal Reserve (Fed) to consider tightening monetary policy rather than easing.
However, market pricing is increasingly at odds with the Fed’s messaging. Investors are anticipating rate cuts, even as growth and inflation remain elevated. The most recent non-farm payrolls report came in much softer than expected, with only 22,000 jobs added to the US economy in August, leading the market to price in further rate cuts. With inflation still trending above the Fed’s 2% target, this puts the central bank in a tricky position.
3. Tariffs and structural inflation pressures
While tariffs and ongoing trade tensions have sparked renewed inflation concerns, data indicates that the impact will be gradual. In the US, consumer prices are expected to absorb the pressure more slowly than initially anticipated, with inflation peaking in 2026 and subsiding within months. Structural factors such as a persistently tight labour market, continued fiscal expansion, or an overly accommodative Fed could drive a more sustained rise in inflation, but these are not part of our baseline expectation for the next year or two.
US companies have adeptly navigated the shifting tariff landscape, mitigating the feared "tariff cliff." By front-loading inventories and altering trading partners, firms have managed to maintain steady import levels while reducing reliance on higher-tariff countries like China. This adaptability, coupled with softer consumer demand, has led many companies to absorb tariff costs by narrowing profit margins. While this strategy has its limits, it suggests that any tariff-induced price increases will unfold gradually over time.
4. European policy uncertainty
European fixed income markets are navigating a period of heightened fiscal and political risk. In the UK, recent government bond syndications have been well received, but the market’s focus is shifting to the upcoming Budget in November and the potential for tax reforms. The UK Office for Budget Responsibility may lower its long-term growth forecasts, forcing the government to identify additional savings or revenue sources. But yields on long-dated UK government debt are now at attractive levels, with 30-year gilt yields now at their highest level in 27 years3.
Germany is undergoing a structural shift from bond scarcity to surplus, with increased issuance prompting a repricing of Bund yields and a compression of spreads. The country’s forthcoming Q4 issuance plan will be closely watched, as it sets the tone for supply and demand dynamics going into 2026. Many investors are now considering the balance of the appeal of higher yields on German government debt against the risks of oversupply.
France has recently appointed a new prime minister after the previous premier lost a pivotal confidence vote in parliament, amid debate around fiscal consolidation and spending cuts. While the broader fiscal trajectory is unlikely to change dramatically, political risk remains a key variable, with the potential for policy shifts, budgetary surprises and market reactions across the euro area periphery and core.
5. The enduring role of global diversification in portfolios
Against the backdrop of these complexities, global diversification has never been more critical. Historical analysis shows that no single bond market consistently outperforms, and global indices have delivered superior risk-adjusted returns and lower drawdowns4. For investors concerned about volatility and idiosyncratic risk, broadening exposure across regions and sectors can enhance portfolio resilience and risk-adjusted return potential5.
An allocation to global government bonds, available through Vanguard funds including the new Vanguard Global Government Bond Index Fund, also allows investors to reduce their correlation to equity markets. As the chart below indicates, while certain single-country government bond exposures have positive correlations to equities, the overall correlation of global government bonds is negative to both US and global equities (as represented by the S&P 500 and MSCI World, respectively). Thus, global government bonds offer not only broad diversification within fixed income, but also diversification in a portfolio context, as they can help to balance out some of the risk associated with equities.
Investors can reduce correlation to equities by going global
3-month rolling correlations, over the last 10 years
Source: Vanguard and Bloomberg.
Note: Rolling 3-month correlations, based on NAV prices, data range from 31 December 2014 to 31 January 2025. Indices: Global government bonds: Bloomberg Global Treasury Developed Countries Float Adjusted Hedged EUR. UK government bonds: Bloomberg Global Agg GBP Government Float Adjusted Total Return Index. Euro government bonds: Bloomberg Euro Government Float Adjusted Total Return Index. Italy government bonds: Bloomberg Italy Government All Bonds Total Return Index. US equities: S&P 500 Index. World equities: MSCI World Index.
As liquidity buffers erode and political tensions intensify, global government bond exposures can help investors build portfolios that can weather the challenges that may arise, while still harnessing the yield and diversification benefits high-quality fixed income has to offer.
1 Source: Bloomberg, as at 12 September 2025.
2 Source: Bloomberg, US GDP Economic Forecast, as at 28 August 2025.
3 Source: Bloomberg, from 31 December 1997 to 31 August 2025. Yield as of 31 August 2025 was 5.6%.
4 Source: Bloomberg, for the period 31 July 2005 to 31 July 2025.
5 Source: Vanguard, calculations used Bloomberg data, from 31 January 2009 to 31 August 2025. Risk-adjusted return calculated using annualised return over annualised standard deviation during that period.
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