UBS Favors 3- to 5-Year Bonds for Income After Global Selloff

Following a global bond selloff, UBS strategists see more attractive opportunities to earn income, or carry, but are urging investors to avoid chasing higher yields in longer-dated debt. The bank recommends a defensive shift, favoring investment-grade bonds in the three- to five-year maturity range where the income potential is more favorable relative to the risk.

Caution on Long-Duration Debt

UBS has become more tactically cautious on duration after a sharp increase in interest-rate volatility and an aggressive bear flattening of global yield curves, according to a recent note. While credit spreads have remained relatively resilient, the bank highlights rising spread volatility in long-dated investment-grade and parts of the high-yield market as a sign of growing investor nervousness.

Several factors contribute to this cautious stance:

• Rising Treasury Yields: UBS identifies a U.S. 10-year Treasury yield approaching 5% as a critical threshold. A move beyond that level could make it difficult for credit markets to remain insulated from the rates selloff.
• Heavy Debt Issuance: An increasing supply of long-term debt, partly driven by large technology and infrastructure spending related to AI, is putting pressure on the market.
• Investor Demand: Investors are demanding more compensation for holding longer-maturity bonds due to the elevated interest-rate volatility.

Preferred Investment Strategy

Ad

In this environment, UBS's model suggests a move up in quality and a focus on the middle of the curve. The bank's preferred positioning is to take profits in U.S. high-yield bonds and reallocate to global investment-grade credit, particularly in the three- to five-year sector.

UBS finds the European front-end particularly attractive after the recent repricing of monetary policy. U.S. investment-grade bonds in the same three- to five-year bucket also screen well, as their spread volatility is lower and their correlation with equities has decreased. The bank also stated a preference for cash over synthetic credit exposure and for European credit over U.S. credit.

Positioning Risks

Beyond market dynamics, UBS flagged that investor positioning itself is a potential risk. Exposure to credit from systematic investors like Commodity Trading Advisors (CTAs) is already stretched. The bank warned that a sudden pickup in volatility from negative headlines could force these investors to quickly cut their long positions, potentially accelerating a market downturn.