Please see the below article from Tatton Investment Management discussing central bank hawkishness, French debt concerns, and the changing relationship between equities and bonds -received this morning – 21/09/2026.
Hawks to the rescue
We start this week in a positive frame, after last week’s surprisingly good performance. The preparatory trade and AI-cooperation talks dominate the headlines, ahead of the Washington Trump-Xi meeting. Meanwhile crude oil is on a downswing, which may hopefully start to bring down petrol, diesel and other refined outputs.
Last week, despite geopolitics and AI warnings, was more about bonds and central banks. It may be counter-intuitive but central banks raising rates can help long bond yields go down.
The Fed raised US rates by 0.25 percentage points, as Chairman Warsh flexed his inflation-fighting credentials. The BoE held but signalled a November hike. And the BoJ closed the week with its own widely expected 0.25 percentage point rise. Some tough talk ultimately calmed nerves rather than unsettling them.
Warsh’s speech briefly rattled bond yields and stocks, but markets recovered as inflation expectations fell. We read this as a credibility boost: the Fed squeezes now, but containing inflation will allow markets to breathe later. It was a particular win for Fed independence, with Trump backing Warsh despite lambasting the hike.
The BoE’s hawkish signal helped gilt yields, although its plan to sell its stock of long-term gilts back to the treasury was perhaps even more impactful. The BoE’s sale of bonds accumulated on its balance sheet has contributed to gilts’ underperformance, as has the gilt market’s structural imbalance (too many inflation linked and long-dated bonds). The treasury will now buy back its long-term debt, effectively swapping it for shorter-term borrowing. That will help further ease the maturity imbalance.
The BoJ ultimately backed the theme of monetary credibility, calming bonds despite the dovishness of two politically-appointed members. Its hike might have created some near-term bond market volatility, by unsettling the yen carry trade – borrowing cheaply in yen to buy higher yielding US bond. However, the mixed signal created by the split vote actually caused the yen to weaken.
Central banks could get another disinflation boost if AI companies slow their spending. That’s what tech leaders’ warnings about the need to slow AI development suggest – and the nervous reaction in chip stocks suggests it might be genuine. Conveniently, the existential threat is coming just as AI investment costs are ballooning for tech firms. Central bankers would appreciate a spending slowdown at least.
French debt looms large
British commentators talk up a potential UK debt crisis – but we think the bigger risk lies across the Channel. Gilt yields are higher than French OATs, but that’s more down to structural gilt market imbalances than reckless UK spending. The nominal yield comparison (4.53% 10-year OAT versus 5.27% 10-year gilt) belies worrying signs for France.
OAT yields have overtaken Greece, Italy, Spain and Portugal, and the 10-year is now 1% above German Bunds. OAT yields have risen faster than every other major market in recent weeks, and our preferred fiscal risk measure – the spread between bond yields and swaps – has deteriorated more any other G7 nation.
France’s perilous fiscal position explains why. France’s debt-to-GDP ratio hit 115.6% in 2025, with a budget deficit of 5.1%, both worse than Britain’s 94.3% and 4.3%. Finance Minister Lescure now expects this year’s deficit to come in at 5.4%, with only a vague promise to bring it down next year. Interest payments, while still lower than Britain’s, will rise 25% this year.
The UK’s main problem is debt costs, but France’s core spending is uncomfortably high. It outspends Britain in most categories, leaving a primary deficit worth 3% of GDP. Pensions are the biggest bill, and both Le Pen nor Mélenchon – the frontrunners for next year’s election – oppose reform.
That’s why the dreaded ‘doom loop’ – borrowing to pay off borrowing – is a live threat to France and wider Europe. Europe’s second-largest economy is too big to fail, but too big to bail.
The one silver lining is that an OAT crisis is unlikely to cause another euro crisis, for the simple reason that a genuine OAT sell-off would likely spill over to the equally fiscally lax US. That would weaken the dollar and hence strengthen the euro. That’s some comfort, even as France’s fiscal position keeps deteriorating.
Stocks and bonds split up
For 17 years, stocks have outperformed bonds, breaking the traditional inverse relationship at the heart of diversified multi-asset portfolios. Normally, strong growth lifts stocks but pushes up bond yields (and so pulls down bond prices), while weak growth does the opposite – meaning the two assets move along with the economic cycle. Diversified portfolios therefore invest in both to weather boom and bust.
Since the global financial crisis (GFC), equity outperformance has gone from cyclical to secular. First it was ultra-low rates and profit margin expansion, then it was the AI earnings boom. When stocks have sold off in that time, bonds have often been positively correlated, not the inverse.
The 1970s saw a similar breakdown amid inflation shocks and a change in monetary regime. Today, following the oil shock from the US-Iran war, real yields have risen sharply, but they still aren’t tempting equity investors into bond markets. Equity holders have enjoyed too long and too strong a run to give it up, and on a risk-adjusted basis, stocks still look more attractive than volatile bonds, even at high yields.
The fact equity holders are so entrenched is remarkable, considering that the cheap-borrowing feedback loop that fuelled equities in the quantitative easing years can no longer be sustained under higher rates.
It’s hard to bet against continue equity outperformance, given that AI earnings growth looks impervious to higher rates. AI spending also makes it hard to bet on yields coming down – as tech companies’ grab for capital drains demand from government bonds.
But it’s naïve to think earnings growth will expand forever, especially when the intangibles underpinning it – global trade and stability – look shakier than ever. A rotation might not be imminent, but global instability and historically cheap bonds mean the risks for equities are higher than they have been in years.
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Marcus Blenkinsop
21st September 2026