Rising government bond yields have gripped global markets in recent days, but UBS believes quality fixed income still offers an attractive risk-return profile, arguing that growth concerns will prevent central banks from embarking on aggressive tightening cycles.
The 30-year UK gilt yield hit its highest level in 28 years last week, while the equivalent German bond reached a 15-year peak. Japan's 30-year yield touched a record near 4.2% and the US 30-year Treasury settled above 5.14%, its highest since 2007.
UBS attributed the sell-off to intensifying inflation concerns driven by the continued closure of the Strait of Hormuz, alongside stronger-than-expected inflation data from the US and Japan. Markets are now pricing in a 25 basis point Federal Reserve rate rise over the next year and further tightening from the Bank of Japan.
Political uncertainty has compounded the pressure, with UK Prime Minister Keir Starmer facing mounting calls to step down and President Trump's visit to China failing to produce a breakthrough on reopening the strait.
However, UBS argued that growth risks remain a significant counterweight. European Central Bank president Christine Lagarde has highlighted downside risks to growth alongside inflation concerns, while UBS believes the bar for a Fed rate rise remains high, particularly under new chair Kevin Warsh, who appears inclined to look through one-off supply-shock inflation from tariffs and oil.
In a scenario where the strait remains blocked for a prolonged period, UBS said downside risks to growth could actually lead to rate cuts across major central banks rather than further tightening.
On the demand side, UBS noted that while last week's US Treasury auctions drew less overall appetite than expected, rising yields should attract incremental buyers. Foreign bids in the 30-year auction were described as robust, suggesting international investors are stepping in to lock in returns.
UBS maintained its positive outlook on equities alongside its bond view, arguing that higher yields are unlikely to derail the current rally while growth remains resilient. The bank noted that it historically takes a sequence of rate rises, rather than a single move, for equity markets to falter.
The cancellation of a planned US troop deployment to Poland, following an earlier withdrawal of 5,000 troops from Germany, reinforced UBS's view that Europe is entering a major defence and infrastructure investment cycle.
The bank rates European industrials as attractive, supported by NATO's target of reaching 5% of GDP on defence spending by 2035.
UBS recommended investors hold diversified exposure across sectors and regions while favouring short and medium-maturity quality bonds at current yield levels.