Fixed Income Outlook 2026 The search for income and opportunity

Against a broadly favorable backdrop of resilient economic conditions and rate environments, the outlook for fixed income remains constructive. Sovereign bonds are preferred over corporates but investors should be selective and mindful of inflation and currency risks.

Heading into 2026, we continue to hold a constructive view on prospects for much of the fixed income market, with a general preference for sovereign debt over corporate bonds. The combination of a favorable rates environment and resilient economic backdrop bolster our outlook. While the scope for gains in credit appear less plausible, opportunities may lie in emerging market debt, mortgages, and structured credit.

Sovereign debt

The policy setting of the three major central banks falls conveniently into the three possible states—the Federal Reserve (Fed) clearly leaning towards cutting, the European Central Bank (ECB) at neutral, and the Bank of Japan (BoJ) still in hiking mode. Simplistically, we could translate those different policy leanings into relative return expectations for the coming quarters. Of course, reality is more nuanced, and rate cycles will change as economic conditions evolve. The pricing of those divergent central bank policies led to some dispersion in G7 benchmark yields in Q3 2025, but it would be wrong to assume that the relationship out the curve has broken down completely.

Sovereign debt remains attractive, but investors should be selective about duration and mindful of inflation risks. There is a question mark over the willingness of governments to credibly address fiscal deficits, which could have implications for the long end of some yield curves. The US and France have attracted most attention but they are not alone: Japan and a handful of European countries remain on the bond vigilantes’ radar. Looking forward, the US Treasury market remains the linchpin for global rates markets for the coming year.

Foreign currency exposure is also key. For example, unhedged euro- and Swiss-based investors have seen their currencies’ strength decimate overseas bond returns, especially in US dollar and Japanese yen-denominated debt. Continued currency-driven volatility can be expected and hedging currency exposure should be a priority for many bond investors.

US Treasuries

A significant impact of the US government shutdown was the dearth of data releases. Even in their absence though, it had already become evident that a softer trend was emerging in the US labor market. The inflation picture is more nuanced, and while published data continues to run at a slightly higher than comfortable level for some at the Fed, the trend appears to be (slowly) moving in the right direction. So although the Fed revised its median inflation forecast for 2026 slightly higher in its September economic projections, average inflation is expected to decline to 2.1% by the end of 2027.

Policy easing by the Fed will anchor short-dated US Treasuries and may help draw yields lower if the jobs market weakens further. We are conscious, however, that US yields are close to the lower end of the range seen over the past twelve months. That’s not to say that US yields cannot move lower, it’s simply stating that we got here quite quickly. There are two implications:

1. A correction in yields would not be that surprising and would offer an opportunity to extend or reposition duration.
2. US Treasury returns from current levels are more likely to be in the low-to-mid-single digit range over the coming year. We favor the 5- to 10-year part of the curve. An unexpected and more meaningful contraction in the jobs market could be a catalyst for larger gains given the disinflationary implications and likelihood of a more forceful Fed response.

European and Asian government bonds

Eurozone government bonds face a similar if slightly more constrained setup given diminished prospects of rate cuts and ongoing fiscal concerns. We expect modest returns unless a more significant slowdown unfolds and unlocks additional ECB policy easing. However, returns can be augmented with an active investment approach.

High and rising debt levels, in France and Belgium for example, are raising debt sustainability risks in the medium term. The factors contributing to these increased risks are slow-moving and deeply engrained in the economic and political architecture, making them predictive of long-term ratings trends and offering opportunities for alpha generation. Pension reform in the Netherlands could also lead to significant allocation changes—generating risks and opportunities.

We see potential value in UK Gilts. A sluggish economy and the increasing likelihood of sustainably lower inflation underpins the prospect of more Bank of England rate cuts. With limited fiscal headroom, the aim of the government is to retain market confidence and contain rapidly rising public borrowing while also trying to foster growth prospects. A credible commitment to spending cuts is required to realize the full potential.

In Asia, Japanese government bonds may present an interesting opportunity in 2026. A perceptible end to the rate hiking cycle combined with the potential deployment of Japanese banks’ substantial cash holdings could be a performance catalyst for JGBs, particularly for the belly of the curve. Meanwhile, Chinese sovereign yields are likely to remain range-bound—ongoing disinflationary forces should contain the upside in yields while a less accommodative monetary policy stance will likely limit the downside.

Investment grade credit and high yield debt

Although fundamentals in corporate bonds are still solid, it’s hard to see meaningful upside from here. Generally, spreads for both investment grade credit and high yield debt are unlikely to decline significantly given current low levels. We see more attractive opportunities in mortgages, structured credit, and private credit. That said, corporate credit still offers reasonably attractive carry and as such should remain a core allocation. Interestingly, in terms of market value, BB-rated bonds now account for the largest proportion of the US high yield market compared to B-rated bonds than at any time previously.

Emerging market debt

We retain a positive outlook on emerging market debt, with a slight preference for local currency bonds. An attractive risk/reward profile, declining policy rates, and underlying EM country dynamics such as credit rating upgrades support our positive view.

Hard currency emerging market debt can benefit from underlying US rate dynamics. Spreads have tightened, although a risk-off correction could offer an attractive entry point. US dollar exposure warrants attention, however, as a full year’s coupon could potentially be wiped out by a single quarter’s adverse FX move for non-dollar investors.

Local currency EM debt remains supported by solid fundamentals. Amid a generally favorable inflation environment, the prospect of lower domestic rates could bolster gains, as could any US dollar weakness. As with hard currency bonds, a yield correction could present an attractive entry point.