Rates rally as investors react to risk-off fears Rates rally as investors react to risk-off fears http://www.federatedinvestors.com/texPool/static/images/texpool/texpool-logo-amp.png http://www.federatedinvestors.com/texPool/daf\images\insights\article\volcano-mount-fuji-small.jpg February 20 2026 February 20 2026

Rates rally as investors react to risk-off fears

US bond markets are relatively stable in the face of potential disruption.
Published February 20 2026

February has seen a sharp shift in market tone, chiefly in response to inconsistent equity market performance driving renewed faith that the Fed will ease sooner than later. Bond market reaction has been constructive with more volatility on the longer end, and if economic data continues to reveal positive employment and growth, the recent reaction may reverse and moderate. In the meantime, yields are likely to continue to fluctuate, reflecting a range of US and global forces from potential fiscal stimulus in Japan to AI/software disruption to the impending leadership transition at the Federal Reserve. 

Notable recent market movements

  • Overall, fixed income markets are off to a strong start this year, supported by active policy moves and generally constructive sentiment. 
  • US Treasurys (UST) have rallied hard in February, more than taking back some of the upward movement of January — the 10-year UST yield has been down 19 basis points, a massive move in that market.
  • Treasury curves have flattened, and duration positioning remains difficult, but we continue to see a curve steepening trade as the predominant trend.
  • The Bloomberg Aggregate and Universal are walking side by side currently, as mortgage backed securities (MBS) have outperformed high yield (HY), among other factors. 
  • MBS have rallied sharply following Fannie Mae and Freddie Mac’s $200B MBS purchase announcement.
    Heavy corporate bond issuance has been well absorbed as some investors rotate out of MBS in search of value.
  • Investment grade (IG) and HY bond option-adjusted spreads (OAS) have widened a little on issuance and the AI disruption focus, but discernment creating dispersion is the theme of the year.
  • Abroad, Japan’s Prime Minister Sanae Takaichi secured a decisive parliamentary victory on February 8, increasing the likelihood that her proposed fiscal stimulus will move forward.
  • The yen and Japanese government bonds (JGB) will likely be in focus, with broader spillovers expected across global markets The relevant issue is relative value and where to find it. JGB yields might prove to be enticing. 

Open questions

  • Market expectations for Fed rate cuts are now at more than 2, but less than 2.5, over the balance of the year, beginning in June, and as always, subject to prevailing views. 
  • The composition and direction of the Fed remain cloudy—the nomination of Kevin Warsh answers one question, but raises more about Fed priorities and balance sheet. The minutes from the last meeting noted a balance of views and leaned toward the long pause.
  • Yield curve steepening momentum has faded, likely due to unresolved concerns about potential policy actions to suppress long term yields to support housing affordability and existing home sales. Our view is that the curve steepens over time – think long term wave patterns rather than micro movements.
  • Geopolitical risk continues to be a concern, with Iran the near term issue but Taiwan lingering.

A word about private credit markets

We are frequently asked about the US private credit markets. (Federated Hermes is currently active in private credit outside the US.) Recently, the Wall Street Journal and other sources have written about market softness and heightened investor withdrawals. The difficulty in making generalizations arises from the specific nature of those investments: private. Details on the underlying company financial statements are not publicly available. 

Recent AI driven disruption in the software market is an example of the ripple effect across public and private markets:

  • Software firms have stumbled as new plugins for Anthropic’s Claude Cowork raise fears that users could shift from major platforms (e.g., Salesforce, Workday, Intuit) to more customized, in house AI driven tools, pressuring a $1.2 trillion sector once prized for predictable subscription revenue. 
  • Fixed income has felt the ripple effects, with leveraged loans—holding ~14% software exposure—declining sharply, while HY (4.7%) and IG (5.5%), with smaller weights, have been affected but less severely. 
  • Bloomberg news and other outlets have discussed how software in private credit funds may be listed as business services rather than specifically as software, obscuring its weight in private credit. 


In the US market, we do monitor the business development companies (BDC) as a lens into private credit loans, which have disclosed loan losses and increases to the number of nonperforming loans in their portfolios. According to the Financial Times, investors pulled $7 billion, or 5% of the value of investment portfolio’s (net of debt) from the largest private credit funds over the final months of FY25. And one of the largest names in that area has permanently halted redemptions in a fund that was marketed to retail investors. Apprehension around private credit began with concerns over the net interest income as the Fed lowered rates and then gathered steam on a few, isolated credit events last fall. The software disruption focus has resharpened the pencil. 

There are a number of potential impacts in the US markets in which we participate, such as high yield. With the advent of private credit, issuers have had more funding options (not a bad thing), and many of the lower credit quality and smaller names have opted for the private realm. In turn, this has effectively raised the overall credit quality of the public high yield universe. The inference is that the high yield market is much different now, so perhaps there is value at current levels as history is not an appropriate lens? When we evaluate the market, we assess not only rating agency quality buckets but also historical spread analysis to place today’s valuations in the right context—and still find valuation to be too tight.

Currently, risks remain, particularly around liquidity. If private credit investors decide to reduce exposure to their lower quality names, the public high yield market may become the outlet due to its greater liquidity. Additionally, the expansion of passive strategies (a separate but also important trend) could amplify selling pressure should credit conditions weaken.

Positioning

Against the current backdrop, we continue to see opportunities for fixed income to deliver both yield and total return. With the front end of the US Treasury curve more closely tied to Federal Reserve policy and the long end absorbing risks related to fiscal expansion, inflation, debt and deficits, and global relative value pressures, we favor allocations in the short to intermediate segments of US fixed income. Within this range, investors can tailor portfolios to meet liquidity needs as well as credit preferences, including tax exempt income where appropriate.

Read more about our current views on positioning at Fixed Income Perspectives

Connect with Karen on LinkedIn

Tags Fixed Income . Markets/Economy . Interest Rates .
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Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices.  In addition, fixed income investors should be aware of other risks such as credit risk, inflation risk, call risk and liquidity risk.

Prices of emerging market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

The value of some asset-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private guarantee and/or insurance, there is no assurance that private guarantors or insurers will meet their obligations.

High-yield, lower-rated securities generally entail greater market, credit/default and liquidity risks and may be more volatile than investment-grade securities.

The value of some mortgage-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private insurance, there is no assurance that private guarantors or insurers will meet their obligations.

The spread is the difference between the yield of a security versus the yield of a United States Treasury security with a comparable average life.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.

Investments in debt instruments involve a risk that the entity who issues the contract will not be able to repay the debt or to pay the interest on the debt. If this happens then the value of the investment may vary sharply and may result in loss.

 

Bloomberg US Aggregate Bond Index: An unmanaged index composed of securities from the Bloomberg Government/Corporate Bond Index, Mortgage-Backed Securities Index and the Asset-Backed Securities Index. Total return comprises price appreciation/depreciation and income as a percentage of the original investment. Indices are rebalanced monthly by market capitalization. Indexes are unmanaged and investments cannot be made in an index.

Bloomberg US Universal Index: Is an index that represents the union of the US Aggregate Index, US Corporate High-Yield, Investment Grade 144A Index, Eurodollar Index, US Emerging Markets Index and the non-ERISA eligible portion of the CMBS Index. The index covers USD denominated, taxable bonds that are rated either investment grade or below investment grade.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

Duration is a measure of a security’s price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.

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