The opening salvos of 2026 have cracked new fault lines in the global macroeconomic backdrop to financial markets. One might quietly outweigh all others: if the US Federal Reserve (Fed) meets White House expectations in the months ahead, US interest rates are set to fall, potentially at a time when inflation refuses to. The latest episode of Fidelity Answers looks at what that means for investors and what they can do about it.
The market hiccup in early January was plain to see. The US dollar fell, stocks dipped, and analysts across the board worried that a full-scale conflict between the Fed and the White House was breaking out. But how important is the independence Jerome Powell and his colleagues are perceived to have, and how real is it anyway?
“It’s really important,” says multi asset Portfolio Manager Becky Qin. The core risk, she continues, was written clearly in that initial market reaction at the start of January. If the White House wants rates to fall, and the White House is nominating the next head of the bank soon, then chances are interest rates are going to fall. And they will be doing so at a time when inflation is not retreating as fast as the Fed would like.
That adds up, in short, to the potential for financial repression - where inflation runs higher than the returns on assets, or potentially wages, and investors and consumers have to wear the result. The only people who benefit are borrowers, Washington chief amongst them.
“For the government, for example, higher inflation will work great for the high debt-to-GDP level by gradually eroding away that debt load,” Qin says.
“However, for investors you end up in a world where real yields become negative.”
How do investors deal with this?
Qin’s answer is one of defence and attack: on the one hand using options and hedging to ride out the resulting volatility and on the other focusing on assets with the potential to deliver beyond inflation: popular and in-demand commodities, or shares in strong companies with the potential to outgrow inflation.
That of course is easier said than done in a market stretched by the AI-centred rally of the past year.
But she also thinks there are pockets, especially in the infrastructure and materials bottlenecks spurred by AI investment, that continue to look interesting.
“There is a broadening out from just tech to, for example, more industrial sectors,” she says. “Financials are probably going to do reasonably well. You can see the performance of the Russell 3000 mid cap index.”
Time to come back to emerging markets
Another possible direction of travel is a section of the market that has been out of fashion for a decade: emerging markets benefit both from a weaker dollar and low US interest rates and have been under-allocated in recent years given the rise in base rates of return elsewhere and nerves over defaults. Emerging market (EM) debt had its best year so far this decade in 2025, yet it did so without the full-throated return of major market investors, who remain nervous of a sector which saw a major drawdown in 2022.
“EM debt as an asset class is actually the best-performing asset class within all of fixed income,” says Portfolio Manager Philip Fielding. “We have seen an increased interest again in emerging markets, both from external investors and internal colleagues. But overall, in global portfolios, emerging markets are still a fairly small allocation on the fixed income side in particular.”
Will that change in 2026? Or have investors already missed the boat?
“People fear that they might jump onto the bandwagon too late, and then the wagon derails; in our view, we are at the start of a structural dollar bear market.”
One of the places that is most obviously happening is Brazil, where real interest rates after inflation are 10 per cent. Analyst Andressa Tezine says that makes the case strongly for Brazilian debt this year, but there is risk related to national elections this autumn and of fiscal promises that may worry markets.
“Nothing is ever a no-brainer in emerging markets and investors are being compensated for certain risks in Brazil,” says Fielding.
Another play that stands out for him at the moment is the distinction between countries that are exporters of metals and oil. Gold prices are at record highs, but other precious metal prices have done well, while oil prices - recently under the influence of events in Iran - are structurally lower than in the past.
South Africa, which imports oil but mines heavily, is one economy that is benefitting
“South African fiscal accounts are naturally improving as a result and the current account (is) moving even potentially to a surplus over time. Inflation has been well contained as a result,” he says. “Against this backdrop, we thought and still think that the South African yield curve was too steep, is too steep, and can continue to flatten.”
That doesn’t mean that it will all be plain sailing. The surprises on tariffs keep coming and emerging economies are among the most exposed to the resulting swings in global trade. But another year of dollar weakness would clearly prove supportive.
“Just a stable environment, where the dollar doesn't rally suddenly, is probably enough for emerging market returns to be comfortably ahead of developed market peers,” Fielding says. “In an environment where developed [world] fixed income is under pressure from higher inflation than previously.”
