Macro
The defining shift in the current macro regime is not the level of rates, but the change in the FED’s reaction function. At the January 27–28 meeting, the FOMC held the policy rate at 3.50%–3.75%. The tone, however, is more symmetric. Inflation progress is acknowledged as uneven, cuts remain possible, but the hurdle is higher, and the committee appears more willing to pause for longer if needed. The easing bias that dominated late 2024 has clearly faded.
January CPI rose 0.2% month-on-month and 2.4% year-on-year, with core at 0.3% m/m and 2.5% y/y. Disinflation remains intact at the headline level, but the composition still warrants caution. Service pressures have not fully normalised, and the Fed is looking for a sequence of supportive prints rather than a single benign reading. The implication is straightforward: good inflation data help, but they no longer guarantee an immediate dovish repricing.
The labour market continues to cool without breaking. Nonfarm payrolls increased by 130k in January, unemployment edged to 4.3%, and initial jobless claims fell to 206k. Hiring is uneven, yet layoffs remain contained. This is not recessionary labour data. For equities, that keeps the base case anchored in slower but positive growth, compressing risk premia and shifting the focus toward earnings durability rather than recession timing.
Near-term macro risk now centres on the inflation pipeline and confidence data. PPI, housing metrics and consumer sentiment will determine whether cost pressures are truly fading or stabilising at levels inconsistent with rapid easing. If upstream pricing firms, while labour remains resilient, the Fed’s higher bar for cuts becomes binding, with the front end most exposed.
Globally, Japan has re-emerged as a key swing factor. After lifting rates to around 0.75% in December 2025, the Bank of Japan has left the door open to further normalisation, potentially as soon as March if yen weakness resumes. Japan remains central to global funding conditions. Even incremental tightening increases the probability of carry compression and episodic risk-off moves in crowded, leveraged trades.
A major fiscal risk emerged after the U.S. Supreme Court ruled that President Trump’s emergency tariff regime exceeded executive authority, effectively halting the collection of duties that had generated substantial federal revenue and potentially exposing more than $170 billion in previously collected tariffs to refund claims. While the administration quickly moved to introduce replacement tariffs under alternative statutory authority, the ruling injected fresh uncertainty into the fiscal outlook. For bond markets, the issue extends beyond trade policy. The potential loss of revenue, refund liabilities, and reliance on substitute measures increase uncertainty around future Treasury issuance needs. Even if new tariffs are implemented, the legal complexity and policy instability contribute to a higher policy uncertainty premium, reinforcing upward pressure on the term premium and helping explain the bear steepening observed at the long end of the curve.
Rates
After briefly touching its lowest level of the year, the Treasury market reminded investors how fragile duration positioning remains in an environment where inflation is cooling but not collapsing, growth is slowing but not stalling, and fiscal expansion continues to build in the background.
The 10-year yield fell to 4.017% on February 17, marking the low for 2026. The move extended the post-CPI rally as markets leaned into the disinflation narrative and revived expectations for rate cuts later this year. The rally did not hold. By February 20, the 10-year had risen to 4.086%, the 30-year to 4.753%, and the 2-year to 3.480%.
The key development was not just the reversal but the shape of the move. The week ended with a clear bear steepening, as longer-dated yields rose more than the front end. That shift carries important macro implications.
The early rally was driven by incremental improvements in inflation data, but core inflation remains close to 3%, meaningfully constraining the Fed’s room to ease. At the same time, as outlined in the macro section, the broader backdrop is one of slowing yet still resilient growth. This combination removes the downside asymmetry that initially supported the bond rally. Disinflation without a clear deterioration in activity is not enough to drive a sustained structural decline in yields.
The steepening accelerated after the Supreme Court struck down the administration’s global tariffs on Friday. Markets quickly reframed the decision as a fiscal development. Tariff revenues had contributed to deficit containment. The prospect of refunds potentially exceeding $130 billion, combined with the need for replacement measures, revived concerns about issuance. Any revenue shortfall will likely be funded via additional Treasury bill supply, with implications for repo markets and short-term funding conditions.
The broader story is the rebuilding of the term premium. Since December, long-end yields have increasingly reflected compensation for fiscal expansion, persistent inflation uncertainty, and political risk. Heavy projected issuance in 2026 reinforces that dynamic. Long-end yields are no longer driven solely by Fed expectations. They increasingly embed fiscal credibility and supply considerations. This structural repricing explains why the 2-year remains relatively anchored while the 10- and 30-year segments face upward pressure.
Primary market results confirmed this shift. The $16 billion 20-year nominal auction tailed by 2 basis points, with the bid-to-cover ratio falling to 2.36 from 2.86 in January. Indirect participation dropped to 55.2%, down sharply from 64.7%, signalling more price-sensitive foreign demand. In contrast, the $9 billion 30-year TIPS auction stopped through by roughly 2 basis points and saw indirect participation surge to 78.3%, alongside record-low dealer allocation. Investors are clearly differentiating. Long-dated real yield exposure remains attractive, while nominal duration requires greater concession. Inflation risk remains embedded even as headline prints moderate.
The composition of Treasury buyers continues to evolve. Foreign participation remains meaningful but more tactical. Domestic institutions are increasingly yield-sensitive, and leveraged accounts play a larger role in price discovery. This implies greater auction sensitivity, larger fluctuations in the term premium, and more pronounced curve adjustments around fiscal developments.
Money-market fund assets remain elevated near $7.8 trillion, anchoring the front end. The long end reflects a different equilibrium shaped by persistent deficits, heavy supply, and policy uncertainty.
An additional structural element worth monitoring is the evolving role of the renminbi as a funding currency. The RMB increasingly meets the criteria for a carry funding vehicle: persistently low nominal yields, a clear dovish policy bias, tightly managed FX volatility, and expanding offshore CNH liquidity through Dim Sum bonds and derivatives markets. Earlier depreciation combined with a wide negative China–US rate differential materially improved its carry-to-volatility profile, making RMB funding economically attractive despite capital account constraints.
By contrast, while the Japanese yen remains the dominant and most scalable funding currency due to full convertibility and market depth, its marginal carry appeal is compressing. BoJ normalisation, narrowing rate differentials, and elevated risks of short-covering appreciation reduce expected carry-adjusted returns. Incremental funding flows are therefore diversifying toward RMB channels, even as the yen continues to anchor the global carry complex.
For Treasuries, this matters. Changes in global funding currencies influence cross-border positioning, relative value trades, and demand for dollar duration. Structural shifts in funding dynamics can affect both the term premium and the stability of foreign participation at the long end.
Finally, derivatives markets diverged sharply from Fed messaging. Traders accumulated significant positions in December 2026 SOFR 98.00 calls, targeting a year-end policy rate near 2%, with roughly $40 million in premium deployed and open interest in calls rising materially. Treasury 10-year weekly calls also saw heavy buying, consistent with positioning for a move back below 4%.
This contrasts with the January FOMC minutes, which showed no urgency to cut rates. Policymakers emphasised patience, and Governor Miran moderated his expected path for the policy rate, citing firmer goods inflation and steady labour conditions. The Committee appears divided but not dovish.
The gap between Fed guidance and aggressive easing bets in options increases volatility risk. Either macro data softens enough to validate those positions, or the market will need to reprice. In both scenarios, convexity risk remains elevated, and term premium continues to define the tone for the long end of the curve.
Credit
US credit markets remain supported by resilient growth and strong technicals, but dispersion is increasing beneath tight headline spreads. The macro backdrop of slowing yet still positive activity and restrictive policy rates continues to favour carry, though the margin for error is narrowing.
At the index level, moves were modest but volatile intraweek. US high-yield option-adjusted spreads widened 13 basis points to 280 basis points over Treasuries, led by Caa underperformance. Investment-grade spreads tightened 2 basis points in the week to February 20, delivering 0.02% returns, while high-yield spreads compressed 10 basis points with 0.18% returns. Early risk aversion pushed the Markit CDX North American Investment Grade index to 53.24 basis points, its widest since November 25, before stronger-than-expected durable goods and manufacturing data triggered a sharp rebound, sending junk yields lower and producing the largest one-day gains in more than a week.
Stress is building in pockets of the market. More than 15% of US technology leveraged loans now trade at distressed levels, up from 9.6% at the start of the year, making technology the most pressured loan sector, overtaking basic industry. Technology has also been the worst-performing segment within high-grade credit, raising the risk of broader index-level spread impact given its benchmark weight. Recent losses in software debt highlight a market that is becoming less forgiving of leverage and business model uncertainty, particularly in AI-disrupted segments.
Primary issuance slowed but remains historically elevated. US investment-grade supply totaled $28.1 billion from 24 issuers, down 33% from $41.7 billion the prior week, while high-yield issuance fell 45% to $6.7 billion from $12.2 billion. Dealers expect around $50 billion of high-grade issuance in the week of February 22, versus $27.2 billion sold the prior week. January investment-grade issuance reached $201 billion, near record levels excluding floaters, and February is projected at $190 billion. UBS raised its 2026 US investment-grade technology issuance forecast to $360 billion from $300 billion, citing elevated AI capex and competitive pressures among hyperscalers, reinforcing AI financing as a structural supply theme.
Credit quality remains mixed. Fitch downgraded Alpek to BB+ from BBB- on February 19, reflecting weaker performance and higher leverage, while Moody’s cut CSN to B2 from Ba3, citing its highly leveraged capital structure and deleveraging needs. Although upgrades still outnumber downgrades and rising stars exceed fallen angels, consensus expects some spread widening in February to March following January’s rally, even as leveraged loans and high yield are seen offering the strongest full-year carry profiles.
In structured credit, default concerns are spilling into CLOs. Some retail CLO equity funds have reduced dividends as loan yields fall and default anxiety rises. Meanwhile, Carlyle, BlackRock, Benefit Street Partners and Oak Hill Advisors are accumulating discounted loans ahead of new CLO formation, targeting software, insurance, wealth management and real estate exposures. Ares priced its second European direct lending CLO, a €303.95 million equivalent deal backed by over 70 Western European companies. At the Opal Group CLO Summit, investors expected marginal tightening in CLO spreads, though increased net supply limits upside.
Flows favour quality. High-yield funds saw $152 million of outflows in the week to February 18, versus $84.2 million the prior week, while short and intermediate investment-grade funds attracted $3.77 billion, slightly below $4.32 billion the week before. Strong January absorption reflected seasonal demand, Q4 resets and pre-positioning into year-end. USD credit technicals are expected to remain firm in the first half of 2026, supported by resilient demand and manageable supply.
Issuer activity underscores ongoing capital access. Equinix raised $1.5 billion in a two-part investment-grade deal to fund AI-related data centre expansion, while TransDigm is raising $2 billion across the high-yield bond and leveraged loan markets to finance acquisitions. High-grade fundamentals remain broadly resilient, but with spreads tight and dispersion rising, selectivity and quality bias are increasingly important.