The surge in US Treasury yields has rattled markets, but UBS believes the current market pricing of the Federal Reserve's tightening path is overly aggressive, the actual pace of policy tightening may fall short of expectations, and the overall investment outlook remains constructive.
Recently, the 10-year US Treasury yield jumped nearly 15 basis points in a single day, breaking above 5.1% to hit its highest level since 2007, while the S&P 500 fell 0.8%. This volatility was driven by rising oil prices, strong economic data, and weak Treasury auction results, with fed funds futures implying a probability of an October rate hike rising to 70%, a sharp jump from below 50% just a week earlier.
According to reports, UBS Chief Investment Officer Mark Haefele and his team noted in their latest report that the actual extent of Fed policy tightening is likely to be less than what current market pricing suggests. UBS's base case is for the Fed to hike once more in December and then hold rates steady, while also expecting core PCE inflation to be revised down by 0.2 percentage points this month through the US Bureau of Economic Analysis annual revision, combined with favorable base effects in the first half of next year, the basis for consecutive large rate hikes is weakening.
Rate Hike Expectations May Be Overstated, PCE Revision Becomes Key Variable
UBS believes that despite recent hawkish comments from Fed officials, market pricing of the tightening path has exceeded what fundamentals can support. The report notes that the median of Fed policymakers' rate projections shows rates unchanged throughout 2027, and a downward revision to core PCE inflation would further compress the room for consecutive rate hikes.
Specifically, the upcoming annual revision by the US Bureau of Economic Analysis is expected to lower core PCE inflation by 0.2 percentage points, a data revision that could ease market concerns about sticky inflation. At the same time, base effects in the first half of next year are also favorable, and UBS expects a steady disinflation trend over the next six months. Combined, these factors significantly reduce the need for the Fed to adopt prolonged consecutive rate hikes.
Strong PMI Data Provides Support for Corporate Earnings
The economic data that triggered this round of yield increases also has positive implications in UBS's view. The S&P Global US Composite PMI flash reading rose to 58.4 in September, accelerating expansion for a fourth consecutive month and marking the strongest private-sector activity expansion since July 2021, confirming the judgment that the US economy continues to run steadily.
UBS believes that resilient economic activity provides a favorable environment for corporate revenue and profit growth, and combined with the additional boost from sustained artificial intelligence investment, S&P 500 earnings are expected to grow 25% this year and 14% in 2027. From a global perspective, MSCI All-Country World Index earnings growth is forecast at 26% this year and 14% next year, and the overall improvement in the earnings cycle should support global equities continuing to rise over the next 6 to 12 months.
Rising Yields Create Structural Opportunities in Fixed Income
UBS points out that although debt scale concerns are one factor behind this round of rising bond yields, high debt levels do not automatically mean poor investment returns, and the specific impact depends on how each government manages its debt.
Against this backdrop, UBS maintains an "attractive" rating on fixed income assets, believing that higher initial yields provide a solid income foundation for portfolios. For income-focused investors, short-duration bonds can effectively reduce interest rate risk; at the same time, UBS also sees tactical opportunities in medium- and long-duration high-quality bonds as well as intermediate credit bonds from stronger-rated investment-grade issuers, and recommends investors take advantage of current yield levels to position.
France-Germany Spread Widens, Eurozone Assets Show Divergence
In European markets, the France-Germany 10-year government bond spread widened by 6 basis points on Wednesday to 110 basis points, the highest level since July 2012, when then-ECB President Mario Draghi vowed to defend the euro "whatever it takes." The French 10-year government bond yield rose 15 basis points to 4.66%, a significantly larger increase than German bunds.
UBS believes this spread widening mainly reflects market concerns about France's fiscal position and next year's presidential election, rather than being simply dragged down by rising global bond yields. France's fiscal deficit exceeds 5% of GDP, and financing costs for its 2.7 trillion euro government debt have risen sharply, which could lead to further credit rating downgrades. Currently, French government bond yields are even higher than BBB-rated Italian government bonds, indicating the market has already positioned them as rate-sensitive high-beta assets. Nevertheless, UBS does not believe a severe fiscal crisis is imminent and maintains a positive view on eurozone equities, believing that improving economic activity and earnings growth can offset valuation pressure from modestly higher yields.
Gold Under Short-Term Pressure, Medium- to Long-Term Allocation Value Remains
Gold came under pressure and fell below $4,300 per ounce, trading around $4,280 per ounce, with a cumulative decline of more than 8% over the past month. Hawkish Fed rate hike expectations and a strong dollar constitute short-term headwinds.
In response, UBS said that under rate hike expectations and a "higher for longer" interest rate outlook, gold's short-term volatility may increase further, but it remains constructive on a 12-month horizon. Continued central bank gold purchases, reserve diversification needs, high government debt levels, and geopolitical uncertainty all provide medium- to long-term support for gold. UBS views a gold pullback to around $4,000 per ounce as an opportunity for investors to add positions, and forecasts gold prices will rise to $5,400 per ounce around September 2027.
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