After valuations returned to pre-conflict levels, UBS recommends prioritizing credit carry rather than increasing directional risk
AI summary card
After valuations returned to pre-conflict levels, UBS recommends prioritizing credit carry rather than increasing directional risk
The report argues that after two rounds of volatility in 2026, credit repricing was driven mainly by yields rather than spreads. The current environment is better suited to harvesting carry through structures such as Europe over the US, cash bonds over synthetic credit, the front end over the long end, and HY over IG.
- So far in 2026, global markets have gone through two volatility episodes - the February tech sell-off and the Middle East conflict - but credit spreads have been more resilient than rates.
- The report argues that this repricing is a 'yield story' rather than a 'spread story,' and rates are one of the few asset classes that have not shown complacent pricing toward the oil price shock.
- As valuations return to pre-conflict levels, UBS recommends that investors prioritize maximizing income while minimizing directional exposure as much as possible.
- Preferred carry trades include: long Europe versus US spreads, long the front end of the credit yield curve versus the long end, long cash bonds versus synthetic credit, and long HY versus IG within synthetic credit.
- The model shows that Europe 1-3 year ultra-short maturities are the most attractive, with a loss probability below 15% over the next 12 months; US IG 1-3 year also screens well.
Report interpretation
Overview
In this global strategy report, UBS discusses how investors should reallocate multi-asset portfolios once valuations have returned to pre-conflict levels. The report notes that markets have experienced two volatility events so far in 2026 - the February tech sell-off and the Middle East conflict - but credit spreads have remained broadly resilient, especially relative to rates. Therefore, this round of credit market adjustment looks more like one driven by yields rather than by a sharp widening in spreads.
Core views
The core view is that this is not the time to simply add directional risk; instead, investors should prioritize harvesting carry. UBS still maintains its view that spreads may widen later in the year, with the main concern coming from private credit risk. But in the short term, the balance of risks has shifted more toward de-escalation than renewed escalation, and market positioning shows that even bearish investors are unwilling to add further downside exposure. Based on this, the report favors being long Europe versus US spreads, long the front end of the credit curve versus the long end, long cash bonds versus synthetic credit, and long HY versus IG within synthetic credit.
Analysis framework
The report uses a multi-asset carry-to-volatility framework to compare return compensation and volatility risk across regions, maturities, cash bonds versus synthetic credit, and IG versus HY. The model provides an optimized allocation recommendation every three months and incorporates the recent tech equity correction and Middle East conflict into the three-month volatility window to update the relative attractiveness of each maturity bucket.
Methodology notes
A measure of asset attractiveness based on carry earned per unit of volatility risk
The report compares carry and realized volatility across different credit assets, regions, and maturities to identify allocations where return compensation is high relative to risk.
A carry optimization allocation model updated every three months
The model recommends that investors adjust exposures to cash bonds, CDS, IG, HY, US, Europe, and emerging market credit without materially increasing directional exposure.
Option-adjusted spread scenario simulation
The report uses key levels for indices such as CDX IG, CDX HY, iTraxx Main, and iTraxx Xover to assess potential outcomes under different spread paths.
Asset mapping & comparison
Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).
- European credit spreadsMore favored relative to the US
- Strengths
- The report recommends maintaining a long bias toward Europe versus the US, viewing it as more attractive in carry allocation.
- Weaknesses
- If European macro or political risks rise, the relative advantage may weaken.
- Comparison
- A relatively better allocation than US spread exposure.
- Risks
- Renewed geopolitical escalation, slower European growth, or an energy price shock could weigh on performance.
- Front end of the credit curveMore favored relative to the long end
- Strengths
- Europe 1-3 year and US IG 1-3 year screen well, while Europe ultra-short maturities have a loss probability below 15% over the next 12 months.
- Weaknesses
- If rates continue to rise sharply, front-end yields may still come under pressure.
- Comparison
- Better than most long-end maturity buckets, especially after adjusting for volatility.
- Risks
- Rate shocks, inflation shocks, and front-end repricing risk.
- Cash bondsMore favored relative to synthetic credit
- Strengths
- Cash bonds still look more attractive on a carry-to-volatility basis.
- Weaknesses
- Liquidity may be weaker than CDS, making exit costs higher during periods of market stress.
- Comparison
- Relative to CDS, cash bond volatility has not risen to the same extent due to hedging demand.
- Risks
- Deteriorating liquidity, worsening credit fundamentals, and valuation pullbacks.
- HY within synthetic creditMore favored relative to IG
- Strengths
- The model recommends increasing credit beta within synthetic credit by going long HY versus IG.
- Weaknesses
- HY is more sensitive to risk appetite and default expectations.
- Comparison
- Offers higher carry than IG but comes with higher credit risk.
- Risks
- Economic downturn, rising default rates, and spillover from private credit risk.
- CDX EMCash plus synthetic investors can add risk exposure, but the synthetic-only model still maintains a Short CDX EM position
- Strengths
- Under some portfolio constraints, the model recommends adding CDX EM risk exposure.
- Weaknesses
- Signals are inconsistent across different investor constraints.
- Comparison
- Recommendations differ between cash-plus-synthetic portfolios and pure synthetic portfolios.
- Risks
- A stronger US dollar, emerging market financing pressure, and geopolitical risk.
Key data
- Major volatility events in 20262 timesThe report mentions the February tech sell-off and the Middle East conflict.
- Europe 1-3 year credit loss probabilityBelow 15%The report says Europe ultra-short maturities have a loss probability below 15% over the next 12 months, making them the most attractive in the carry screen.
- US/Europe HY long-end volatility positionClose to long-term averageCompared with other assets whose volatility rose to around the 65th-70th percentile, the 5+ year long-end volatility of US and European HY remains close to its long-term average.
- Historical rarity of curve flatteningLess than about 4% of cases over the past 30 yearsThe report says this extreme curve flattening has been rare outside hiking cycles.
- Model volatility window3 monthsThe model has already incorporated the tech sell-off and the Middle East conflict into the three-month volatility window.
- Recommended allocation update frequencyEvery 3 monthsThe model recommends the optimal carry allocation or reallocation for the multi-asset portfolio every three months.
Impact & implications
For portfolios, the implication of the report is that, against a backdrop where valuations have recovered and spreads do not meaningfully compensate for geopolitical and private credit tail risks, investors should focus more on structural relative value and carry efficiency rather than one-sidedly chasing a rebound in risk assets. Cash bonds still appear more attractive than CDS because CDS volatility has risen materially due to increased demand for liquidity hedging; European short-end and US short-end IG also exhibit relatively favorable risk-reward characteristics.
Risks
- Private credit risk continues to build and could push credit spreads wider later in the year.
- The Middle East conflict or other geopolitical events could re-escalate, putting risk assets back under pressure.
- An oil price shock could trigger inflation pressure, push rates higher, and depress credit asset valuations.
- Rising demand for liquidity hedging in the CDS market could amplify synthetic credit volatility.
- Multi-asset correlations may diverge from historical patterns, weakening the effectiveness of the carry-to-volatility model.
- Thinner market liquidity and a high-volatility environment could lead to adverse valuation adjustments.
What to watch
- Whether more market-overlooked stress signals emerge in private credit.
- Whether the Middle East situation continues to de-escalate or re-escalates.
- Changes in loss probability and volatility for front-end credit assets such as Europe 1-3 year and US IG 1-3 year.
- Whether the volatility gap between cash bonds and CDS continues to widen.
- Key levels for indices such as iTraxx Main, iTraxx Xover, CDX IG, and CDX HY under OAS scenarios.
- If negative news pushes volatility higher over the next four weeks, whether CTAs reduce long positions in iTraxx Xover.