Key points
- Technology market volatility
- Bond yields’ structural drivers
- China as an AI disruptor
Equity markets: The tech and non-tech divide
Equity markets have diverged into two different worlds: tech and non-tech, with correspondingly different interactions with global bond yields. Over the summer, the oil price was the key driver of bond yields. Rising oil prices and bond yields led – as expected – to declines in non-tech equities. Tech equities, however, were largely impervious as the positive earnings outlook mattered more.
The recent sell-off in tech stocks, however, has led investors to seek safety in government bonds, driving yields lower even as oil prices rise. Defensive (non-tech) equities have also benefited from the lower yields and inflows from investors looking for perceived safe havens.
What happens next will depend on whether tech market volatility subsides. Investors have been disappointed by the earnings of some tech stocks. Given the high expectations implicit in the strong gains for tech indices year to date, there may be little room for further disappointment.
Government bonds: Many moving parts
Government bond yields have increased significantly this year, worsening financial conditions and sparking worries about debt sustainability. While no second-round effects are yet visible, the unanticipated inflation acceleration is certainly a key variable behind bond yields.
Another important variable is major central banks’ monetary policy U-turns. For example, market-based expectations initially indicated the Fed would cut interest rates in 2026. Instead, the Fed hiked rates and current market expectations suggest another two hikes over the next 12 months.
However, this is just one side of the story. There are structural factors as well; in particular, the oversupply of long-term bonds resulting not only from governments’ need to fund their spending, but also from changing demand. The government bond market has transitioned from being driven by price-insensitive investors with seemingly infinitely elastic balance sheets, to highly price-sensitive investors with constrained balance sheets. Therefore, the expected interest rate peak, government bond risk premiums and the shape of the yield curve have become once more an integral part of fixed income allocation decisions.
An industrial renaissance in progress
The artificial intelligence buildout is generating a capital investment cycle of an historic scale, reshaping industrial supply chains, power infrastructure, manufacturing geography, and sovereign economic strategies across both developed and emerging markets. Surging financing and extensive order backlogs confirm the structural nature of this wave, anchored primarily by the US and China.
However, this industrial renaissance is highly uneven and bottlenecks are shifting. US-led AI capital expenditure is driving the growth disparities; non-AI driven-economies are facing slower expansion. Moreover, China’s investment and production-biased policies are adding pressure to traditional manufacturing sectors.
Simultaneously, as a byproduct of its own tech competition drive, China could emerge as a disruptor within the AI trade. Operationally, power availability and grid interconnection timelines are increasingly outweighing core tech infrastructure, land, and labour as the primary deployment constraints.
Consequently, development is shifting toward behind-the-meter and off-grid facilities –connected directly to solar, batteries, or power plants – to accelerate energisation and reduce grid dependence. These trends will likely lead to divergent investment outcomes in 2027 and beyond.
Implementation ideas
Flexibility within euro credit
The euro credit market remains resilient, supported by strong fundamentals, despite geopolitical tensions and elevated energy prices. While investment grade spreads remain relatively tight, high yield spreads have widened in recent weeks. This has restored some value in the higher-yielding segments of the market, but it also calls for greater selectivity.
With the third-quarter reporting season now under way, company results will be key to confirm the strength of corporate balance sheets. Overall, conditions remain supportive with elevated all-in yields and an attractive income. Tactical duration positioning could potentially be beneficial, particularly given the market has already priced in expectations of future European Central Bank interest rate hikes. An agile, flexible approach could help investors capitalise on opportunities across the euro credit spectrum, including high yield and subordinated debt, while mitigating idiosyncratic risks.
Inflation and rates fluctuation protection
Geopolitical tensions are sustaining high levels of inflation uncertainty, particularly due to volatile energy prices, while financial conditions remain restrictive. The distinctly hawkish turn by various central banks means short-dated inflation-linked bonds look attractive, given their near-term growth potential and inflationary risks. Given that multiple interest rate hikes are already embedded in market pricing, both inflation indexation – bonds where the principal is linked to inflation – and the potential returns investors can earn from holding the bond offer potential attractive opportunities through year-end. Short-duration strategies can potentially help protect against the risk of higher inflation as they are less sensitive to interest rates compared with all-maturities strategies.
Environmental solutions enabling AI development
The artificial intelligence revolution is not just about investing in semiconductors and technology. Behind the rapid growth of AI is a significant build-out of critical enabling infrastructure, particularly power and water. Rising data centre demand requires more electricity generation, stronger and smarter grids, transformers, battery storage, energy efficient cooling, and reliable water infrastructure. Meeting this growing demand while supporting the transition towards a lower-carbon power system will require significant investment in environmental solutions. We believe this creates a broad, multi-year potential investment opportunity in the providers that enable the continued expansion of AI.
Asset Class Summary Views
Opinions draw on investment team views and are not intended as asset allocation advice.
| Rates | ||
| US Treasuries | – | The Federal Reserve kept its key interest rate between 3.75% and 4.0% in October but indicated that inflation remains too high. Markets expect the official rate to peak around 4.50%/4.75%. We expect some pressure on US 10-year government bond yields over the next few months, and anticipate they will rise to 5.10% |
| Euro – Core Govt. | = | The European Central Bank did not hike in October but remains open to doing so in December. However, this is already priced in by markets, with futures reflecting close to three hikes in the next 12 months. We think a December rate hike will be the last, but given oil and gas prices, pressure will remain on government bond markets |
| Euro – Govt Spreads | + | Government bond spreads have widened and appear attractive. We remain positive on Italy and Spain since the current high yields help compensate for the volatility |
| UK Gilts | + | Our highest conviction overweight position is in longer-dated gilts, as UK inflation may start to ease and growth may have peaked |
| JGBs | – | We expect the yield on Japanese 10-year government bonds to rise back above 3% in 2027 |
| Inflation | + | US 10-year inflation break-evens are close to their pre-Iran war levels so look attractive. In the eurozone, break-evens have risen versus the start of the conflict but would still be attractive if there is further escalation in the Middle East |
| EM Hard Currency | = | We are moving to a more neutral position |
| EM Local Currency | + | We are positive on local currency bonds but remain very selective |
| Credit | ||
| USD Investment Grade | + | We see potential opportunities in upcoming primary bond issuance. Spreads are attractive but have not widened as much as in euro investment grade |
| Euro Investment Grade | + | Spreads widened quickly in October and stood at their widest of the year so far. Weakness has been driven mainly by other asset classes (euro government bonds, technology stocks) rather than investment-grade bond fundamentals |
| GBP Investment Grade | + | Overall yields remain very attractive |
| USD High Yield | + | Selectivity is key in this asset class, even more so than at the beginning of the year |
| Euro High Yield | + | We are taking advantage of weakness in the asset class to add to our holdings, but are being very selective |
| Equities | ||
| US | + | Technology and AI continue to drive returns, while US business activity remains resilient amid a broader manufacturing recovery. However, higher inflation and interest rate expectations still present risks to returns. We are diversifying tech risk with exposure to the financial sector |
| Eurozone | = | Earnings momentum is slowing down which is reflected in modest positioning. Higher energy prices, tighter monetary conditions and political risks are short-term headwinds |
| Japan | = | Corporate fundamentals remain supportive, but valuations are now higher and the market is undergoing a reduction in exposure to equities. BoJ policy and yen uncertainty also argue against a directional view. Bank stocks look attractive |
| China | – | Policy support and attractive valuations provide a degree of downside protection, but consumer spending trends remain subdued and visibility on a sustained earnings recovery is still limited |
| Emerging Markets | + | Valuations are attractive on a forward earnings basis |
| Sector | + | Preference for energy-related stocks, reflecting a positive view on commodities, and for global financials for their attractive valuation and diversification characteristics |
| Investment Themes* | + | Long-term positive on AI buildout, grid electrification and carbon transition strategies |
* BNP Paribas Asset Management has identified several themes, supported by megatrends, that companies are tapping into which we believe are best placed to navigate the evolving global economy: Automation & Digitalisation, Consumer Trends & Longevity, the Energy Transition as well as Biodiversity & Natural Capital; source: BNP Paribas Asset Management.
