As we look forward to 2026, we remain quite optimistic on the outlook for the bond market.
We expect to see growth slowing across most of the developed market and the emerging-market world. Central banks will have a tricky situation on their hand as they think about balancing what will be a slowing growth environment and an increasing unemployment rate with an inflation mandate that is above their target in most areas.
This is going to create some consternation across these central banks, and I think is going to lead to some concern in the market that central banks may not be able to reduce interest rates. Despite that, we think central banks will have to respond to the growth outlook or the employment outlook side of their mandate.
We are seeing more job layoffs and would expect that to continue as we move into 2026. That’ll give the Federal Reserve ample opportunity to cut rates two to three times. We think there’s further room for rate reductions in the UK. We think the ECB is roughly where it should be, and we would expect some modest rate rises out of the Bank of Japan as we go into 2026.
Lower interest rates, a slow growth environment and moderate inflation all tend to be the right factors for fixed-income market returns. We would expect to see bond yields move lower from here over the course of the next 12 months. We would expect to see curves steepening. That is a good backdrop for fixed income.
We highly recommend in this environment that clients hold duration. Duration should serve as a good risk offset, should we see a wobble in equity markets or any risk market. We think duration priced at these levels does leave ample room for rates to rally in those risk-off sort of environments.
Cash rates most likely will be coming down in 2026 as central banks reduce interest rates further. And with over $8 trillion in cash, we still see more of that money moving into the bond market.
We’ve also heard a lot about foreigners’ selling of US bonds and foreign bonds. We haven’t seen that yet. The official data, even the anecdotal evidence from our clients, continue to show that clients want to own US duration and want to own US assets.
If we look to Europe, we would think a similar dynamic presents itself, right? Both European bonds and UK gilts, we think rally in a risk-off environment. We think both instruments will provide that diversification that is so valued by clients in their asset allocation strategy.
It’s going to be an environment where we recommend clients hold duration, but they also hold that barbell approach, holding both that duration and credit exposure. Duration so that you get that risk-off type of an instrument and holding credit because it gives you that additional yield, that additional income, which is so valuable to clients.
Credit metrics look pretty good at this stage. Now there’s been a lot of talk that credit spreads are tight, and we would very much agree with that. Credit spreads could go a bit wider from here, but we definitely think that there is a ceiling.
All-in yields matter. And while we talk a lot about spreads, those all-in yields are what’s really important. As investment-grade spreads in the US hit 5%, as high yield hits 7%, right, in Europe a little bit lower—those tend to be leveled where we’ve seen buyers come in, and we think this environment is no different.
This is going to be a year where there’s a lot of factors working in favor of fixed income. However, clients have to stay flexible—2026, like any other year, will be a volatile year, and it will create opportunities.