US rates strategy: UBS favors US rates relative value as hawkish Fed pricing meets a growing Treasury financing challenge

Overview

This US rates strategy report assesses the implications of a hawkish Fed, inflation dynamics, Treasury financing needs, demand conditions and balance-sheet policy for the Treasury curve and inflation markets. UBS argues that outright yields are elevated relative to its fundamental framework, but near-term policy repricing and future supply risks support patience on duration and a preference for relative-value positions.

Core views

UBS argues that US growth remains disproportionately supported by AI-related investment while non-AI investment is weak. Its forecast table shows real GDP growth of 2.2% in 2026 and 1.9% in 2027, with business fixed investment projected to grow 8.8% in 2026 before slowing to 3.9% in 2027. Fiscal policy is expected to shift from a net positive contribution in 2026 to a drag in subsequent years. Inflation analysis emphasizes that core CPI has continued to decline from pandemic highs while core PCE has not fallen to the same extent; UBS believes trend inflation is likely closer to core CPI and notes wage-inflation measures are at levels seen when PCE inflation averaged 2%. The report sees limited near-term room for market-implied Fed expectations to fall after the market priced roughly 90bp of tightening over the following year and participants anticipated a broader tightening cycle. UBS nevertheless judges Treasury yields high relative to fundamentals. Its yield-curve fair-value regressions link level and slope dynamics to OIS rates, non-bill Treasury float relative to GDP, oil prices, inflation swaps and growth expectations. The front-end repricing hurt the belly of the curve, so UBS remains patient on duration rather than pursuing an outright long position. It favors 2-year-forward 2s/10s steepeners over spot steepeners on risk-reward grounds, and forecasts Q4 2026 Treasury yields of 4.50% for 2-year notes and 4.80% for 10-year notes. Treasury financing is the report's central structural concern. UBS expects fiscal deficits above 6% of GDP in coming years and a larger financing gap from fiscal 2027 onward. The T-bill share of marketable debt is already above Treasury's 20% long-term target; if coupon auction sizes were unchanged, UBS estimates bills would exceed 32% of marketable debt by fiscal 2029. It therefore expects coupon-auction increases to begin in May 2027, concentrated in 2- through 10-year maturities while 20- and 30-year auction sizes are reduced. Net coupon issuance is projected at $1.22tn in 2026 and $1.26tn in 2027, only roughly $40bn higher year on year. Larger long-end buybacks—whose quarterly maximum purchase amount has risen by $32bn, equivalent to roughly $54bn in 10-year duration—should reduce net duration supply in coming quarters. UBS projects duration supply to be stable in 2027 before rising $133bn to $2.75tn of 10-year equivalents in 2028. Supply relief is not complete: UBS estimates corporate issuance will add roughly $250bn of fixed-income supply in 10-year Treasury equivalents in 2026. Demand indicators are mixed. Bank Treasury demand slowed sharply in the second quarter, foreign private investors sold $29bn of long-term Treasuries in July, and China had sold $48bn year to date. Repo conditions have remained orderly, with SOFR 10–11bp below the top of the federal-funds target range. UBS expects Federal Reserve assets to grow by about $150bn next year and reserve balances to remain near $3.0tn, but expects $264bn of net bill issuance, after Fed purchases, in Q4 2026 and warns this could tighten funding conditions as money-market-fund inflows slow. For relative value, UBS stays bullish on swap spreads and holds 5s/30s swap-spread curve steepeners. It sees potential for further long-end spread widening and spread-curve steepening, supported by deregulation optimism, US exceptionalism and a concentration of duration supply in credit markets. On inflation, it sees mixed front-end valuations: market pricing implies headline and core inflation roughly 40bp above UBS forecasts, while 1Yx4Y inflation swaps appear somewhat cheap after the FOMC. UBS is neutral on TIPS, targets 10-year breakevens at 235bp at year-end, and prefers long inflation swaps relative to breakevens because IOTAs are tight. In its broader multi-asset context, UBS assumes global growth remains near its long-run average as AI trade and investment offset energy disruption and other headwinds. It forecasts 2026 real GDP growth of 3.1% globally, 2.2% in the US, 4.5% in China and 0.8% in the eurozone. The number of additional central-bank hikes is tied to the duration and severity of Middle East energy disruption, leaving rate uncertainty elevated even as UBS's medium-term Treasury yield forecasts decline through 2027.

Analysis framework

UBS combines macro forecasts for growth, inflation and Federal Reserve policy with Treasury financing projections, debt-maturity composition, buyback assumptions, supply-demand indicators and yield-curve valuation regressions. It then translates those inputs into yield, curve, swap-spread and inflation-market forecasts and relative-value trade preferences.

Methodology notes

• OtherYield curve analysis

  Treasury yield-curve fair-value regression

  UBS estimates Treasury yield level and slope fair value using OIS rates, Treasury float, oil, inflation swaps and growth expectations to judge whether yields and curve segments are rich or cheap relative to fundamentals.

• Industry AnalysisSupply-demand framework

  Treasury and fixed-income duration supply-demand analysis

  The report compares projected Treasury issuance, buybacks, Federal Reserve purchases, corporate issuance and investor demand to assess the net duration supply facing the market.

• Other

  Inflation-swap fair-value regression

  UBS estimates 1Yx4Y inflation-swap fair value from RBOB gasoline futures, the VIX Index and core CPI over the prior three years to assess relative valuation.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• US Treasuries

  UBS sees yields as elevated versus fundamentals but remains cautious on outright duration because of policy repricing and future supply risks.

  Strengths

  Forecast yield declines into 2027; buybacks and projected Fed purchases reduce near-term net duration supply.

  Weaknesses

  Hawkish Fed repricing has hurt the curve belly.

  Comparison

  Forward 2s/10s steepeners are preferred to spot steepeners on risk/reward.

  Risks

  Larger financing needs, bill issuance and muted foreign demand may pressure funding and duration markets.

• USD 2-year-forward 2s/10s SOFR steepeners

  Preferred curve-steepening relative-value position.

  Strengths

  UBS views forward steepeners as offering better risk/reward than spot curve steepeners.

  Comparison

  Preferred over spot 2s/10s steepeners.

  Risks

  Further policy repricing or a different path for Treasury yields could impair the position.

• USD 5s/30s swap-spread curve steepener

  UBS maintains the position on expectations of further long-end spread widening.

  Strengths

  Supported by deregulation optimism, US exceptionalism and duration supply concentrated in credit markets.

  Comparison

  Long-end spreads are expected to drive continued steepening in the spread curve.

  Risks

  The expected supply and demand backdrop may not develop as projected.

• TIPS and inflation swaps

  UBS is neutral on TIPS but prefers long inflation swaps relative to breakevens.

  Strengths

  1Yx4Y inflation swaps appear somewhat cheap after the FOMC.

  Weaknesses

  IOTAs are tight and front-end inflation valuations are mixed.

  Comparison

  Inflation swaps are preferred to breakevens.

  Risks

  Inflation outcomes and market pricing may diverge from UBS forecasts.

Key data

• US real GDP growth forecast2.2% in 2026; 1.9% in 2027UBS forecast
• Q4 2026 Treasury yield forecast2-year 4.50%; 10-year 4.80%UBS forecast
• Net coupon issuance$1.22tn in 2026; $1.26tn in 2027Projected Treasury net coupon issuance
• 2028 Treasury duration supply$2.75tn in 10-year equivalentsProjected to rise $133bn from 2027
• Net bill issuance$264bn in Q4 2026Net of Federal Reserve purchases
• 10-year breakeven target235bp at year-endUBS remains neutral on TIPS
• China Treasury flows-$48bn year to dateNet Treasury sales

Impact & implications

UBS sees a tension between elevated yields relative to fundamentals and a longer-term financing and duration-supply challenge. This leads it to prefer forward curve steepeners, long-end swap-spread steepeners and selected inflation-swap exposure rather than an outright duration position.

Risks

• A longer or more severe Middle East energy disruption could require more central-bank tightening than UBS assumes.
• Treasury financing needs, rising bill issuance and corporate duration supply could worsen funding conditions.
• Foreign Treasury demand remains muted, while bank demand slowed sharply in the second quarter.
• Policy and macro risks, elevated energy prices and further monetary tightening could limit credit-spread tightening.

What to watch

• The scale and duration of Middle East energy disruption and its effect on the number of Fed and ECB hikes.
• Treasury refunding announcements, especially whether coupon-auction increases begin in May 2027 and their maturity allocation.
• Bill issuance, money-market-fund flows, repo conditions and reserve balances.
• Federal Reserve balance-sheet reforms, reserve-management purchases and any shortening of SOMA's maturity profile.
• Foreign and bank demand for Treasuries, including Treasury TIC flow data.