Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 656

The case for staying the course in credit

When we think about the current volatility, we are reminded of a prescient quote from Russian revolutionary and president Vladmir Lenin:

“There are decades where nothing happens and there are weeks where decades happen.”

Time will tell whether the Iran war is indeed one of these periods where decades happened.

As for markets domestically, higher oil prices have collided with sticky headline inflation and a hawkish central bank. Australian government bonds have sold-off aggressively in March, with 3 and 10-year bond yields now at ~4.8% and 5% respectively (refer Chart 1). Moreover, despite the Reserve Bank of Australia (RBA) increasing the cash rate twice in February and March 2026 to 4.1%, interest rate markets as of 20 March were pricing in another ~70bps of tightening by the end of 2026 to 4.8% (i.e. close to another three 25bps increases in the RBA cash rate).

Chart 1: 3-year and 10-year Australian Government Bond Yields (%)

Source: Bloomberg, Mar 2026.

This higher rebasing of interest rates has a commensurate impact on corporate bond yields, with 5-year major bank T2 and triple B corporate yields now both back above 6% for the first time since late 2023 (refer Chart 2).

Chart 2: 5-year T2 and BBB Corporate Yields (%)

Source: NAB, Yarra Capital Management Mar 2026.

By contrast, the movement wider in investment grade (IG) credit spreads of ~20bps only takes us back to late 2025 levels (refer Chart 3). The orderly behaviour of IG credit thus far is testimony to the power of higher risk-free rates and outright yields (i.e. lessening the pressure on credit spreads to achieve investor return targets). Moreover, for the most part risk markets are still pricing in a speedier return to normalcy, enabling central banks such as the RBA to raise rates despite the heightened uncertainty.

Chart 3: 5-year T2 and BBB Corporate Bond Spreads (bps)

Source: NAB, Yarra Capital Management Mar 2026.

When uncertainty in markets is elevated, playing the averages over the medium term typically remains the best course of action. In many ways, what we’ve experienced in recent months, turbocharged by the Iran war, is a mini 2022 period with one important caveat. After the normalisation of bond yields in 2022, travel time to higher bond yields in 2026 was shorter and much less painful for interest rate duration positions.

From our perspective, while holding some duration has been reflected in performance in recent months, our focus has remained on taking advantage of higher outright yields and locking in attractive income. Portfolio running yields for the IG quality Yarra Enhanced and Higher Income funds are now well above 6% and approaching 7%, levels we last generated in 2023/24. Maintaining duration in portfolios at these elevated levels is advantageous for sustaining performance throughout the remainder of 2026.

In addition to higher bond yields, the rebuilding of more rate hikes in market pricing has significantly flattened the yield curve. The difference between the 3 and 10-year bonds is now under 30bps, down from a peak of ~120bps during the liberation day selloff in April 2025 (refer Chart 4). In this environment and if sustained, a flatter yield curve should result in a steeper credit curve with investors at the very least demanding increased term premiums in the current environment (i.e. higher credit spread compensation for longer dated securities).

Chart 4: Yield Curve – 3s10s (bps)

Source: Bloomberg, Mar 2026.

While credit spreads remain well behaved, if the current interest rate pricing is even half realised – i.e. reflective of some RBA future hikes – then a significant deflationary impulse for the Australian economy is likely. This is especially the case when combined with an appreciating $A, much higher petrol prices, greater application of AI tools across the economy and a retreating public sector following a more austere May Federal budget. Resultant higher unemployment and much weaker economic growth is likely to reverse current interest rate settings through the course of 2026/27. Therefore, despite a small impact in recent months, maintaining interest rate duration in portfolios continues to make sense at current levels.

In an environment of much weaker growth and higher unemployment, rallying bond yields is likely to result in credit spreads moving wider, with the current calm in credit giving way to a further rebasing of spreads. Our focus remains on locking in favourable income and using duration and curve to protect the portfolio and strongly position us to take advantage of the transition in return composition, with credit spreads likely to comprise a greater proportion of future outright yields following a significant decline in risk free rates.

 

Phil Strano is Head of Australian Credit Research at Yarra Capital Management, a sponsor of Firstlinks. This article contains general financial information only. It has been prepared without taking into account your personal objectives, financial situation or particular needs. Both the Yarra Enhanced Income and Higher Income Funds are zero leverage funds, providing attractive yields.

For more articles and papers from Yarra Capital, please click here.

 

  •   1 April 2026
  • 1
  •      
  •   

RELATED ARTICLES

Things may finally be turning for the bond market

The two key risks facing investors

What to do about the growing chorus of market correction warnings?

banner

Most viewed in recent weeks

Why spending more in early retirement can improve lifetime income

Conventional wisdom encourages retirees to preserve superannuation. But if those likely to qualify for the Age Pension later in life spend a little more today, it may deliver higher lifetime income and a more stable retirement.

Is it time to bail on Australian stocks?

For generations, Australian investors have backed banks, miners and dividends. But has that loyalty come at a cost? A look at the numbers raises an uncomfortable question about where future returns will come from.

Meg on SMSFs: What do we think about reversionary pensions these days?

Reversionary pensions have long been a staple of SMSF estate planning, but are they still the best option? Meg Heffron revisits a once-clear favourite and asks whether changing super rules have shifted the balance.

Testamentary trusts survived the trust tax. The drafting battle has just begun.

The fight over testamentary trusts looked settled. Then the draft legislation arrived. Hidden in a technical detail is a question that could force many families to rethink wills they thought were already future-proof.

How does the 4% rule stack up?

The 4% rule has long been retirement's gold standard. But after a difficult period for investors, fresh analysis suggests a more conservative approach may significantly improve the chances of making savings last.

The new capital gains tax trap for your portfolio

Investors have long accepted one portfolio rule without much question. A major tax shift could change that calculation entirely, forcing difficult trade-offs between risk, discipline and an overlooked cost lurking beneath.

Latest Updates

Exchange traded products

It’s time for LICs to die

A high-profile dividend cut and a prominent fund manager’s apology have reignited a long-running debate. If investors can access similar exposures more cheaply and efficiently elsewhere, what exactly is keeping LICs alive?

Taxation

Will investors be better or worse off under new housing tax changes?

Housing tax reforms have sparked warnings of market turmoil and promises of greater fairness. But after modelling nearly two decades of property data, the results suggest winners and losers may not be who many investors expect.

Retirement

Three considerations before reshaping your legacy plan

Many retirees hope to leave a legacy. Proposed trust tax reforms could force families to rethink. The question is not how much to leave behind, but whether today's inheritance plans will still make sense as circumstances change.

Investment strategies

Why experienced investors still get markets wrong

Retirement is approaching. Markets are noisy. And every headline seems to demand action. The biggest investment risk isn't fear, greed or market volatility, it often arrives disguised as research and sensible risk management.

Shares

Why pay more for less?

Conditions were stacked in favour of professional investors in 2026. Most still fell short, raising questions about where investors should look for value. Meanwhile, an alternative strategy continued to make its case.

Investment strategies

Bleeding air out of the bubble

Equity valuations have fallen sharply over the past year, yet investors have largely been spared the volatility and losses that typically accompany a de-rating. What explains this unusually orderly reset? Here are five key drivers.

Strategy

Has AI gone rogue?

We worry about AI becoming conscious. But what if consciousness isn't the issue? The more unsettling possibility is a machine capable of pursuing objectives relentlessly, without motives, emotions, or awareness of any kind.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.