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Market commentary
US Treasuries sold off sharply in the third quarter of 2026, with persistent inflation, a resilient labour market, and a hawkish Federal Reserve driving yields materially higher. After a brief rally in early July, Treasuries came under sustained pressure as stronger-than-expected August payrolls — nearly three times consensus — reignited inflation fears and cemented expectations for further tightening. The Federal Reserve delivered a 25 basis points (bps) rate hike in September, lifting the fed funds target to 4.00%, with officials signaling additional increases remained on the table. The 10-year yield broke decisively above 5% around mid-September, reaching its highest level since 2002 by quarter-end. Over the quarter, the 10-year Treasury yield surged 85bps to 5.29% while the 2-year yield rose 71bps to 4.89%, resulting in a modest steepening of the yield curve with the 2s10s1 spread widening from approximately 29bps to 39bps.2
Asia USD investment grade credit markets remained broadly resilient during the quarter, with credit spreads widening modestly by 2 bps to 98 bps, driven primarily by weaker performance in China technology and bank senior debt. Investor focus remained on the implications of the region's accelerating Artificial Intelligence (AI) driven data centre buildout, with Asia Pacific (APAC) capacity expected to more than double by 2030. Market participants increasingly assessed the impact on Chinese hyperscaler credits3, while elevated debt issuance by US technology companies to fund AI-related capital expenditure contributed to global supply pressure. Within Greater China, Baidu was downgraded to A-, reflecting structural pressures in its core search advertising business and weaker long-term growth prospects. In Korea, credit fundamentals continued to benefit from the AI investment cycle. Moody's upgraded SK Hynix to A3 while S&P upgraded the company to A- with a Positive Outlook, citing strong earnings visibility, robust free cash flow generation and continued balance sheet strengthening. The Korean government's introduction of production tax incentives for strategic industries, including semiconductors and batteries, was also viewed positively for issuers such as LG Chem. In India, senior bank spreads softened amid strong issuance activity, although market technicals are expected to improve as issuance moderates following the closure of the Reserve Bank of India’s (RBI) Foreign Currency Non-Resident (FCNR) swap window. Rating activity remained constructive, with Moody's upgrading JSW Infrastructure to Baa3 and Fitch upgrading JSW Steel to BB+ with a Positive Outlook, supported by deleveraging and improving leverage metrics. In Indonesia, investor attention centred on the appointment of Destry Damayanti as Bank Indonesia Governor and cabinet changes under President Prabowo, with policy continuity and reaffirmed fiscal discipline helping support investor confidence. Elsewhere in Southeast Asia, Fitch revised the outlook on Thailand's sovereign outlook to BBB+ Stable from Negative, citing an improving government debt trajectory, greater political predictability, and better-than-expected economic resilience. In Malaysia, Fitch downgraded Genting Berhad and Genting Malaysia to BBB- from BBB and Resorts World Las Vegas to BB+ from BBB-, reflecting expectations of persistently elevated leverage as the group funds expansion projects. In the Philippines, Moody's affirmed Rizal Commercial Banking Corporation's Baa3 rating but revised the outlook to Negative due to rising asset-quality pressures and weaker profitability expectations.
Performance in Asian USD high yield markets was supported by spread tightening, improving sovereign fundamentals and selective rating upgrades. Market attention was drawn to SoftBank's US$11.1 billion equivalent multi-currency bond issuance, reportedly the largest high-yield corporate offering on record, undertaken to support its continued investment in AI-related initiatives. Within China's property sector, the transition towards completed-home sales is expected to delay developers' cash collection and place additional pressure on sector liquidity. Fitch upgraded Vanke to CC following the successful completion of its distressed debt exchange, while New World Development continued to navigate liquidity challenges despite bond exchange initiatives and shareholder support aimed at addressing near-term maturities. Elsewhere in Greater China, Macau gaming credits remained constructive, with Wynn Macau and MGM China reporting resilient operating performance and continued deleveraging progress. In India, Vedanta Resources completed a debt exchange and tender offer that reduced near-term refinancing risks. S&P revised UPL's outlook to Positive on improving leverage metrics and operating performance, while Delhi International Airport and GMR Hyderabad International Airport were upgraded, with the latter qualifying as a rising star. Piramal Finance also reported resilient earnings supported by lower funding costs. Among Asian high-yield sovereigns, Pakistan's credit profile strengthened following S&P's upgrade of the sovereign rating to B from B-, reflecting progress under IMF-supported reforms, fiscal consolidation and improved external liquidity. Sri Lanka also continued its recovery trajectory, with Fitch upgrading the sovereign to B- with a Stable Outlook, citing macroeconomic stabilisation, improving external balances and ongoing structural reforms.
Performance review
The Asian Credit portfolio underperformed its benchmark in 3Q26:
Negative contributors:
- Overweight in US duration
- Overweight exposure in Australia, United Kingdom and Japan government bonds
Positive contributors:
- Overweight in Indonesia quasi-sovereign bonds
- Underweight in China Technology, Media and Telecommunications and Asian bank bonds
- Currency positioning in Japanese yen and Australian dollar
Strategy Positioning
Against a backdrop of a broadly resilient quarter for credit markets, the strategy moderately reduced its underweight position in credit spreads relative to the benchmark during the quarter. Within credit, allocations were increased to Asia Pacific banks, China convertible bonds, Middle East quasi-sovereign bonds, U.S. technology bonds and Indonesian utilities, where valuations remained attractive. Offsetting this, exposure to Australian corporates and Korean corporates was reduced following a period of spread tightening, which limited further upside potential. Towards the end of the quarter, positions in Indonesian quasi-sovereigns and Mexican sovereigns were reduced as heightened rates volatility increased the risk of spread widening.
In rates, the strategy maintained overweight duration positions in the UK, Australia and Japan amid a sharp repricing in global long-end yields. These positions were established following a material rise in yields, as valuations appeared increasingly compelling against a backdrop of moderating growth expectations and easing geopolitical tensions. However, the sell-off extended beyond expectations, driven by higher term premia and persistent inflation concerns. We continue to believe that the underlying U.S. economy is weaker than headline data suggests. The benefits of rising asset prices remain concentrated among higher-income households, while lower- and middle-income consumers continue to face challenges. Furthermore, recent growth has been disproportionately driven by AI-related sectors and investment. This underpins our long-term overweight position in U.S. Treasuries, as we expect weaker underlying economic conditions to eventually lead to lower interest rates.
The portfolio also retained a small allocation to euro-denominated credit, with the associated currency exposure fully hedged back to the U.S. dollar. In addition, exposure to Hong Kong credit issued in Australian dollars was added, reflecting attractive spread differentials relative to its comparable U.S. dollar bonds, with the associated currency exposure tactically hedged. In foreign exchange, we remain an overweight Japanese yen stance as structural support improved, with potential repatriation by the Japanese pension investment fund, indications of US support for yen intervention and the Bank of Japan's rate hikes.
Q4 outlook
Global
Resilient on the Surface, Slowing Beneath
Markets have become increasingly focused on resilient growth, persistent inflation and rising fiscal deficits. As a result, US Treasury yields have moved sharply higher, with investors now pricing additional Fed hikes over the coming year.
We believe markets may be placing too much weight on the resilience of the economy. While oil prices remain elevated and continue to represent the main inflation risk, other components of inflation are beginning to show signs of moderation. At the same time, labour market conditions are softening. Following recent revisions, US payroll growth has averaged just 80,000 jobs year-to-date through August, well below the long-term average, suggesting underlying momentum is weaker than headline growth implies.
AI-related investment continues to support activity, but much of this growth is being driven by capital expenditure and debt-funded spending. Risks around overcapacity and infrastructure constraints, particularly the ability of power grids to keep pace with data centre expansion, are becoming increasingly apparent.
We continue to expect US growth to slow over time. With spending increasingly concentrated among higher-income households and fiscal concerns emerging across the US, UK, Japan and France, we believe markets are underestimating the extent of the economic slowdown that may lie ahead.
Japan remains one of our highest-conviction views. We continue to expect further policy normalisation from the Bank of Japan, supported by potential repatriation flows from the Japanese pension investment fund and growing policy support for yen stability. These dynamics remain supportive for both longer-dated Japanese government bonds and a stronger yen.
Asia
Growth Remains a Relative Bright Spot
Asia remains one of the brighter spots in the global economy. Growth across major markets such as India and Indonesia continues to exceed 5%, while inflation remains relatively benign across much of the region.
China has shown signs of stabilisation, although the recovery remains uneven and domestic demand continues to lag. We believe a more durable improvement will require stronger fiscal support and policies aimed at reviving household consumption.
The key risk for the region remains persistently high oil prices. While Asian economies have weathered the initial shock relatively well, sustained energy prices at current levels would place increasing pressure on growth, inflation and external balances. Several central banks, including Indonesia and the Philippines, have already tightened policy to support their currencies and contain inflationary pressures.
Despite these challenges, we remain constructive on the region. Structural growth drivers, including AI-related investment and ongoing supply chain diversification, continue to support manufacturing activity and capital flows across parts of Southeast Asia, particularly Malaysia and Vietnam.
Credit
Carry Still Matters, but Selectivity Is Critical
Credit markets have remained remarkably resilient. Spreads continue to trade near cycle lows despite elevated government bond yields, persistent inflation concerns and geopolitical uncertainty. While carry remains attractive, we continue to view the risk-reward profile as increasingly asymmetric. Current spread levels leave limited room for further compression, while any deterioration in growth expectations or resurgence in geopolitical risks could quickly lead to bouts of volatility.
In this environment, selectivity remains critical. We continue to favour high-quality issuers with resilient balance sheets and attractive carry characteristics, particularly in the five-year part of the curve where yields remain compelling relative to duration risk. We believe opportunities in Investment Grade bonds offering around 100 basis points of spread over government bonds can still generate attractive all-in yields without requiring investors to move significantly down the credit spectrum. We remain constructive on Indian bank senior debt, selected Taiwan and Japan insurers, and Middle East quasi-sovereigns, where fundamentals remain supportive. Conversely, we remain cautious on segments of the China technology, media and telecommunications sector where increased debt issuance related to AI investment may limit further spread tightening.
Currencies
Strong Dollar Today, Stronger Yen Tomorrow?
The US dollar remains supported by expectations of higher US interest rates and is likely to remain firm until markets begin pricing out further Federal Reserve tightening. That said, we believe expectations for additional rate hikes may prove too aggressive given the ongoing deterioration in labour market conditions and signs of slowing underlying demand. As economic softness becomes more evident and fiscal challenges continue to build, we expect current dollar strength to prove more tactical than structural.
Our strongest currency conviction remains the Japanese yen. Potential the Japanese pension investment fund repatriation flows, further policy normalisation by the Bank of Japan, and the growing risk of a yen carry trade unwind all point towards a stronger yen over time. Importantly, the size of today's global yen-funded carry trade means that any meaningful unwind could create significant pressure for higher-yielding currencies while providing a powerful tailwind for the yen. With the currency still appearing undervalued on a longer-term basis, we continue to see the balance of risks skewed towards further appreciation.
Source: First Sentier Investors as at 30 September 2026
1 Refers to the yield spread between the 2-year and 10-year U.S. Treasury bonds
2 Source: Bloomberg, as at 30 September 2026.
3 Hyperscaler credits refers to the corporate debt securities (bonds and other credit instruments) issued by hyperscale technology companies, particularly large cloud and AI infrastructure providers such as Alibaba and Tencent.
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