Under Pressure

Hedge funds may face more volatility as persistent inflation, rising government-bond yields and debt-financed AI investment increase risks across markets.

• Growth and inflation remain above average, but supply-side pressures from energy, agricultural commodities and industrial metals complicate the traditional “hot economy” narrative; the Nasdaq rose 2.5% in Q3 while the S&P Equal Weight Index fell 2.3%.
• Long-term government yields have surged, with five-year US Treasury yields rising much more than five-year breakeven inflation expectations, suggesting investors demand a higher term premium rather than seeing inflation as temporary.
• France is again under pressure: its 30-year debt yield rose from 449 bps to 554 bps between 1 July and 1 October, while its high debt-to-GDP ratio, high effective tax rate and 2027 presidential election limit near-term reassurance.
• Corporate-credit risks are increasing because higher reference yields and wider spreads raise debt-servicing costs, CCC spreads exceed BB spreads by more than five times, and AI hyperscalers represented over 8% of the US investment-grade market by duration-times-spread risk at the end of September.
• US$266 billion of AI-related bonds had been issued year-to-date, with most AI capex now expected to be debt-financed; banks also expect defaults to rise in 2027, particularly on loans.
• The Q4 stance remains positive on Convertible Arbitrage, Event Driven Special Situations and Discretionary Macro, negative on Distressed and Structured Credit, and neutral on Equity Long/Short because elevated gross exposure and low volatility create deleveraging risks.

Takeaway: Investors should favour strategies benefiting from convertible-bond activity, corporate events and divergent monetary policies, while remaining cautious on distressed and structured credit and monitoring the risk of a crowded unwind in government-bond shorts.