The CIO’s view
Robert Ostrowski
What’s your outlook for 2026?
Fixed income markets enter the new year with a surplus of unanswered questions. To be fair, 2025 answered some. A year ago, we expected a repeat of the post-2016 election environment, with a combination of a doveish-leaning Federal Reserve (Fed) in the short-term and uncertainty about the long-term success of the new administration’s policies resulting in further steepening of the US yield curve. This took longer to evolve than expected.
Defying market expectations and growing political pressure, the Fed paused for nine months before eventually resuming interest rate cuts a year into the cycle. Gradually, tariffs-driven uncertainty and resultant volatility gave way to investor consensus that the Fed’s dual mandate will be manageable going forward, rate cuts will continue toward a lower fed funds rate and a more dovish Fed and Chair will be in place in 2026.
We wish it were that simple, but expect it won’t be – too many unanswered questions remain. Inflation has not spiked as soon and dramatically as expected from tariffs, but neither has it made convincing progress toward the Fed’s target of 2%, remaining elevated and susceptible to tariff impacts (pending Supreme Court action). Employment is softening, but due to significant increases in investment, GDP is solid and the economy is not exhibiting anything near what would normally require the extent of rate cuts currently being ‘demanded’ by the administration. A current contrary view gaining momentum is that the Fed doesn’t need to cut at all, as the economy, at a macro level, doesn’t need stimulation, and risks of elevated inflation remain. The extended bear steepener (short rates falling more than long rates) is evidence of this conflicted point of view in the markets.
Adding to the mix is a more uncertain US political environment. The recent off-cycle election, dominated by the Democrats in the few key races that gathered the nation’s attention, suggests that the 2026 mid-terms might disrupt the administration’s current policy path currently discounted in the market. Mid-term US election years have been systematically less positive for risk assets, creating another risk to consider for already tight credit spreads. Our expectation is that the market may fade US exceptionalism and look to a reglobalisation theme, but in an ex-US fashion i.e., looking to emerging market bonds and currencies.
The challenge in 2026 will be avoiding the complacency of believing a new normal exists in which policy disruptions including tariffs and irrational artificial intelligence (AI) exuberance are easily absorbed. Though US recession risks appear at bay, the slow-growth economy can easily change direction. Increased unemployment, and spiking inflation, aka stagflation, remain in play over the next year. Credit events and layoffs are also making the news, while critical economic data reporting has been limited. Managing yield curve and duration exposure, as well as finding value across a range of assets that are priced for perfection will continue to be required priorities.
Further themes that will matter next year:
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