US Treasuries market softer data supports front end; long-end yields remain elevated on fiscal risk

Weekly bond market update: Softer data but the long end doesn’t care

Cooling inflation and slowing wage growth are supporting the front end of the curve, but fiscal risk and heavy Treasury supply continue to keep long-term yields elevated.

• Inflation and labor pressures are easing : Three-month core inflation is around 1.7% annualized, while wage growth is at a five-year low.

• The growth mix looks different : Corporate profits are near historic highs as a share of GDP, while labor compensation is near a 75-year low, alongside an AI-led capex boom.

• The curve is sending two messages: Softer data supports the front end, while fiscal risk, heavy Treasury supply and term premium weigh on the long end.

• Fiscal credibility remains the long-end constraint : With the deficit near 6% of GDP, softer inflation alone may not be enough to bring long yields materially lower.

• We favor carry over a large duration bet : Attractive yields support higher bond allocations, favoring short

intermediate duration, select spread sectors and steepeners over the long end.

US macroeconomic data continued to soften last week

The July Consumer Price Index (CPI) was broadly more benign than feared, with headline inflation rising just 0.1% month over month, and core inflation up 0.2%. More encouragingly, three-month annualized core inflation is now running around 1.7%, while shelter inflation continues to moderate. This follows the weaker payroll report we discussed last week, while average hourly earnings growth has now slowed to 3.2% year over year – its weakest pace in roughly five years. Taken together, this does not look like a conventional wage-price spiral. That leaves us with something of a conundrum: inflation momentum is moderating, wage growth is at a five-year low and the labor market is moderating – yet the 30-year Treasury yield has moved above 5.3%, its highest level since 2007.

Soft labor, a resilient economy and persistent fiscal pressure

Part of the explanation may be that a softer labor market does not necessarily mean a weak economy. Strength is increasingly coming from elsewhere, particularly corporate profits and capital expenditure, with the AI investment cycle providing significant support to activity. The scale is extraordinary: global AI investment is expected to exceed $1 trillion this year, while Goldman Sachs estimates the major hyperscalers could deploy around $5.3 trillion of capital between 2025 and 2030 – increasingly resembling a generational infrastructure buildout rather than a conventional technology capex cycle.

Figure 1 highlights another unusual feature of the current backdrop: corporate profits as a share of gross domestic product (GDP) are close to historic highs, while labor compensation as a share of GDP has fallen to a roughly 75-year low.

Figure 1: US labor compensation’s share of GDP falls to a 75-year low, while corporate profits’ share surges

Source: Bloomberg, Federal Reserve Economic Data, as of 8

“Labor share” is calculated as compensation of employees, received, at current prices divided by US GDP at current prices. Corporate profits are US corporate profits without inventory valuation adjustment and capital consumption adjustment, profits after tax at current prices, divided by US GDP at current prices.

We would be cautious about describing this simply as “profit-driven inflation,” but it does suggest that this cycle looks different from a conventional wage-price spiral. Labor is weakening, while profits, investment and corporate pricing power remain strong. This may help explain both the resilience of the economy and the fact that inflation has remained somewhat sticky despite increasingly benign wage dynamics.

The front end believes the Fed can stay on hold. Does the long end?

The front end of the yield curve has responded conventionally to the softer data. Expectations for a September Federal Reserve (Fed) rate hike have fallen sharply, with the implied probability now around 35%, as inflation, wages and labor-market data increasingly argue for patience. The long end doesn’t seem to care. Last week’s 30-year Treasury auction cleared at 5.216%, the highest auction yield since 2001. Importantly, this wasn’t a failed auction: the bid-to-cover ratio was a healthy 2.39x. There is still demand for long-duration Treasuries – but increasingly so only at a price.

Fiscal concerns remain central to that repricing. With the federal deficit still running at roughly 6% of GDP, large financing requirements and rising interest costs continue to weigh on the long end, with investors demanding greater compensation for fiscal uncertainty, inflation risk and the amount of duration they are being asked to absorb. At the same time, softer inflation and labor-market data are reducing expectations for further Fed tightening and providing support to the front end. That combination continues to reinforce our bias toward curve steepeners and a defensive stance at the very long end of the Treasury curve.

Indeed, that is exactly what we saw last week: the 2-year yield fell while the 10-year rose, leaving the Treasury curve steeper despite softer inflation and growth signals. There is an interesting paradox here. The front end increasingly believes the Fed can stay on hold. The long end increasingly appears to be asking whether it should.

In fact, one of the better outcomes for the long end might now be a Fed hike. Not because 1.7% three-month annualized core inflation and five-year-low wage growth necessarily warrant one, but because a hike would demonstrate that the Federal Open Market Committee (FOMC) remains serious about inflation and could help anchor longer-term inflation expectations and policy credibility. The problem is that the incoming data makes such a hike increasingly difficult to justify. The Fed may therefore stay on hold precisely when the long end would benefit from a stronger signal of inflation discipline. Absent that signal – or a more credible fiscal adjustment – the market may continue to demand a higher term premium, leaving the curve biased toward further steepening.

The political consultant James Carville famously joked that he would like to be reincarnated as the bond market because of its ability to intimidate everybody. That observation feels increasingly relevant today. With the deficit around 6% of GDP and 30-year yields at their highest since 2007, the bond market is increasingly acting as the arbiter of fiscal credibility.

Opportunities and challenges for investors

Overall, we remain constructive on fixed income and believe the significant repricing in yields supports a higher strategic allocation to bonds, particularly given generous nominal and real yields and compressed equity risk premia. However, we see the opportunity increasingly as one of income and carry rather than the capital appreciation that investors became accustomed to in the post-Global Financial Crisis period. We are therefore more constructive on the short and intermediate parts of the curve, while remaining cautious at the long end, where persistent fiscal concerns and heavy government financing requirements are likely to continue to weigh on valuations.

Within spread sectors, we favor securitized credit, municipals and selected emerging markets, where attractive all-in yields and better relative value offer more compelling risk-adjusted income than generic corporate credit. Taken together, we think investors are best served now with a focus on front

intermediate duration, selective spread exposure and curve steepeners, given our view that portfolio returns will now be driven primarily by carry rather than by any large directional duration bet.

Read the team’s latest quarterly market outlook, Fixed income markets now demand a mix of tactical offense and resilient defense.

Important information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This article is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and

or strategic decisions. Past performance is not a reliable indicator of future results, prices of shares and the income from them may fall as well as rise and investors may not get back the amount originally invested. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored.

US Multi-Sector Fixed Income Team

Weekly bond market update: Payrolls throw Warsh a lifeline

Monthly markets review - July 2026

Weekly US bond market update: The Fed spoke, markets questioned