Top convictions:
- Confidence in US Federal Reserve (Fed) easing could open the way to duration extension in 2026; but inflation may overshoot
- Tight valuations and rising dispersion warrant an increasing bias to quality
- Re-visit emerging debt, Asia for selective re-risking opportunities
To those who may have doubted the relevance of fixed income, I offer 2025 as a compelling counterpoint. This year, the asset class has delivered precisely what it promises – reliable returns and portfolio stability – quietly disproving predictions of its demise. Yet, as we look ahead, the path becomes more nuanced.
Let me begin with credit markets. After a prolonged period of quantitative easing, they have resumed their intended function, responding to renewed inflation and growth with strength. Returns have been robust, driven by both capital appreciation and attractive coupon income – levels we haven’t seen in years. But the market now faces a series of tests: uncertainty surrounding the US economy, the policy decisions shaping it, and the trajectory of inflation.
As the extraordinary run in gold this year shows, alternatives are not always easy to find.
The risk, as it has been for some time, is that these elements may not align well. My central view, as I write in mid-November, is that US inflation will likely exceed the market expectations priced by inflation-linked bond breakevens, at a time when the economy, though resilient, is beginning to slow. This divergence will have meaningful implications for bond markets.
CHART 1
Credit risk
The collapse of First Brands in September and credit markets’ reaction may be an early warning of what is to come. An economic downturn inevitably affects corporate fundamentals, and steering clear of defaults will be critical to preserving total returns.
Investment grade spreads are extremely tight, which is a concern – but they are tight with some justification. Rates are high and demand for credit from high quality issuers has been strong.
Investor interest has leaned more heavily toward credit than sovereign debt, and I expect that trend to continue. While spreads may widen, the elevated starting point for yields should cushion income strategies against significant downside.
CHART 2
Some of our fund managers argue that European investment-grade credit offers more value than its US counterpart, that bank debt presents attractive opportunities compared with non-financial paper, and that emerging markets may offer superior value compared to developed world government and corporate bond markets.
Policy balance
Sovereign debt markets will be shaped not only by broad trends but also by policy nuance. On the surface, the environment appears favourable – rates across developed markets are trending lower, which should support bond appreciation.
The policy balance in the United States is a risk. The yield curve has steepened in recent months, reflecting investor reluctance to hold longer-dated debt because of concerns over issuance volume and inflation risk. Steepener trades (buying short-term and selling long-term bonds) seem a logical response.
Can Washington navigate this challenge? So far, it has done better than many expected. Earlier this year, I sat in conference rooms listening to predictions of failed auctions and a squeeze on US government debt by October. Instead, the market has remained resilient. Rates are high, and there is room for compression – but only if demand for US debt remains strong.
Our portfolio managers and analysts are actively debating the next moves. Many are avoiding duration for now. Some are questioning the long-term status of Treasuries and the price at which they will be funded. If 2025 has been defined by over 100 central bank rate cuts globally, 2026 could well be shaped by policy divergence.
Dollar bill
Geopolitical tensions will continue to influence currency markets, but I expect the broader trend of de-dollarisation to deepen. Confidence in the Fed’s rate trajectory appears weaker than in other central banks. Economically, the UK may have a clearer path to lower rates in the coming year, for example.
This shift is particularly relevant for emerging markets. With confidence in the dollar at a multi-year low – and potentially falling further – several emerging market currencies offer compelling alpha opportunities, but the overall picture is supportive for all emerging market (EM) assets.
CHART 3
It’s been a recurring theme among investors in 2025, but the flows into EMs have yet to follow. I expect that to change in the months ahead.
Big choices
Looking forward, several major decisions loom. The appointment of the next Fed Chair and the US midterm elections will be pivotal. Meanwhile, Asia’s exporters must decide how to deploy their surpluses. Recent evidence suggests a growing preference for stores of value outside the dollar – but as the extraordinary run in gold this year shows, alternatives are not always easy to find.
When interest rates are falling, bonds typically become more attractive. But in today’s environment, selectivity and strategic positioning will be key. Fixed income has proven its worth in 2025. The challenge now is navigating what comes next.
