Tuesday's yield surge tests UBS's rate-cut thesis

UBS's strategy relies on the spread between short and long-term yields widening, with long maturities pricing structural risks while short yields have room to drop as disinflation proceeds. That outlook became harder to sustain after Tuesday, when yields across the curve surged back toward levels last seen before the Treasury expanded its buyback program, indicating that traders anticipate rate hikes rather than the cuts UBS needs. Oil is the key variable, with Brent above $92 a barrel and no end in sight to Strait of Hormuz disruptions. Until inflation data confirms the declining impact of energy and tariffs that UBS expects, the bank's focus on quality short-term bonds carries more risk than the note suggests.

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UBS is counting on disinflation and Fed patience precisely as the bond market begins pricing in the opposite scenario.

• UBS observes a global bond selloff early this week, triggered by renewed Middle East hostilities and higher oil costs.
• Iran attacked two US air bases in Jordan, which led to threats of further US strikes, while the US targeted Iranian vessels laying mines in the Strait of Hormuz over the weekend.
• The 10-year Treasury yield climbed to nearly 4.78%, the highest since January 2025, while the 30-year yield reached 5.27%.
• Yields on long-term German, French and Japanese government bonds hit multi-decade peaks, and Brent crude rose above $92 per barrel.
• UBS has raised its year-end projections to 5% for the 30-year and 4.5% for the 10-year Treasury, yet still favors short-to-intermediate-term high-quality bonds.
• The bank expects slow disinflation, a recovery at the Strait of Hormuz, and a patient Fed to back falling yields on the short end of the curve.
• On Tuesday, global bond yields returned to levels last observed before Treasury Secretary Scott Bessent broadened the government's buyback program, as increasing oil prices reignited inflation worries and expectations of rate increases.

UBS continues to favor short-to-intermediate-term government and corporate bonds despite a renewed Middle East escalation pushing long-term yields to multi-year highs, arguing that structural factors raising the back end of the curve do not justify abandoning high-quality short-term debt.

The bank's note cites a familiar series of events behind the latest selloff. Iran targeted two US air bases in Jordan, prompting President Trump to warn of more strikes on Tehran, while the US said it hit Iranian vessels laying mines in the Strait of Hormuz over the weekend. This caused a sharp increase in yields, with the 10-year Treasury reaching nearly 4.78%, its highest since January 2025, and the 30-year climbing to 5.27%. Long-term German and French bonds hit 15-year highs, the 10-year Japanese government bond briefly touched 3% for the first time in 30 years, and Brent crude rose above $92 per barrel.

In this context, UBS has raised its year-end Treasury forecasts, now projecting the 30-year and 10-year yields at 5% and 4.5% respectively. The bank views this as a structural shift, not a temporary risk premium, pointing to ongoing fiscal concerns and heavy AI-related debt issuance as lasting sources of upward pressure on long-term yields. Nonetheless, UBS retains its preference for short-to-intermediate maturities, arguing that those yields still have room to fall. This view depends on expectations that oil flows via the Strait of Hormuz will gradually recover, that inflation from energy and tariff-sensitive items will continue to fade, and that pending methodological changes for pricing digital goods and financial services could reduce core inflation by 0.2 percentage points. On this basis, UBS forecasts the Federal Reserve will keep rates unchanged for the rest of the year, with rate-cut expectations gradually returning as disinflation confidence strengthens.

That thesis appears far more difficult to sustain given subsequent developments. On Tuesday, global bond yields returned to almost two-decade highs, with long-term Treasuries retracing to levels that caused Treasury Secretary Scott Bessent to expand the government's buyback program last month in an attempt to curb the earlier rise. Rising oil prices again triggered the move, but the more important shift is that investors seem to be pricing in additional rate hikes rather than the cuts UBS expects. The bank's disinflation argument could prove correct over time, but with no sign of easing in the Strait of Hormuz disruptions and yields moving away from UBS's base case, the note's optimistic tone seems premature compared to where the market has moved since its writing.