Liquid credit

Hot economies, cold realities: How investors can navigate markets in a divided world

Fixed income prospects for 2026 appear constructive and present a prime opportunity for active managers to generate alpha. Conditions are supportive, and the prospect of further policy support (both monetary and fiscal) is likely to provide support to the medium-term growth outlook and valuations.

That said, risks to growth remain material, warranting close attention to rising tail risks: the growing likelihood of a fiscal crisis as government debt levels continue to climb; the possibility of an AI-driven stock market bubble bursting, escalating geopolitical tensions and conflict as national interests clash with the legacy of globalisation; and the risk of inflation proving stickier than expected. With these risks likely to build into 2026, it is increasingly important for investors to adopt an active and dynamic approach to asset allocation. Actively rotating across the global fixed income universe – while tactically managing interest rate, credit and currency exposure – can better position investors to capture opportunities through the cycle while preserving capital.

Three high-conviction views for 2026:

1. Volatility creates opportunities to add value

More resilient economic growth, supported by fiscal stimulus, coupled with the risk of economies running too hot, could result in higher or stickier inflation. This dynamic suggests bond yields could remain at more elevated levels. Concerns over funding fiscal deficits, rising debt, and growing interest payments suggest that bond yields will remain volatile, particularly at the long end of yield curves. At the same time, policymakers a) actively want lower yields to support national priorities b) are aware that higher bond yields make funding these national priorities more difficult, and c) are equipped with the tools to address these challenges should market conditions deteriorate.

What does this mean for investors?

With many central banks signalling greater caution on further rate cuts, we are more neutral on duration than earlier in their rate cutting cycles. However, given that underlying disinflationary trends remain intact, we retain a bias to add to duration as yields rise but also to reduce exposure when valuations appear stretched. We expect bond yields to remain volatile within a range, trending lower over time, with episodic risks where bond yields may briefly spike higher. These episodes of bond weakness may present opportunities to accumulate duration at attractive levels.
 

2. Add exposure during periods of credit market weakness

A strong rebound in credit markets since the wide credit spread levels we saw around ‘liberation day’ leaves little room for significant spread tightening. Risk assets have shown resilience despite heightened uncertainty from tariffs and geopolitics, supported by generally strong corporate fundamentals. Technical factors, such as attractive all-in yields, continue to provide support for valuations, while more resilient economic growth from the fiscal pulse will tend to be supportive for credit markets. However, the moderately higher cost of capital may be troublesome to the more leveraged components of credit market.

What does this mean for investors?

We expect volatility to offer periodic opportunities and will seek to take advantage of these opportunities as they present wider spread levels.
 

3. Increasing return potential without increasing risk

The increasing “passive is massive” phenomenon, has led to significant concentration in a small number of trillion-dollar stocks, most notably the so-called AI8. With passive funds and ETFs mechanically allocating capital based on index weights, exposure to mega-cap US technology continues to rise. Towards the end of 2025, ~70% of the MSCI World Index was weighted toward US companies, with the AI8 being a large part of that number. Many passive investors underestimate the degree of concentration and reliance embedded in these allocations. And with the already stretched US fiscal position – do you really want to have concentrated exposure to the US?

What does this mean for investors?

Attractive opportunities often lie outside traditional indices. In volatile markets, active management is essential—flexibly investing where we see opportunities for alpha generation, rather than relying on passive strategies with rigid rules and unintended risks. Combining macro insights with detailed fundamental and proprietary analysis helps identify issuers with sound fundamental credit and mitigate downside risk amid uncertainty.
 

Investment implications and strategic considerations

Portfolio Positioning:

In this environment, our view is that buying into market dips during periods of volatility in rates and credit should prove rewarding, as policymakers seek to contain economic conditions that are favourable to economic progress.

Key Opportunities:

Regarding curve allocation, we expect steeper yield curves as the debt sustainability narrative comes back into focus. We prefer the front and intermediate part of yield curves, which we see as likely to benefit from rate-cutting cycles. Regionally, Australia offers attractive relative value, especially at the long end, with a steeper curve and increasing offshore demand. US and Europe are likely to trade within ranges, with market pricing in both broadly fair.

Risks and areas to monitor:

While this core view will likely see investors fare well, keeping a close eye on the growing tail risk scenarios is very prudent. These include a rising likelihood of fiscal crises as government debt levels continue to climb; the risk of an AI-driven stock market bubble burst, escalating geopolitical tensions and conflict; and the risk of stickier inflation as a result of running the economy too hot.
 

Conclusion

Overall, we believe 2026 will reward active, flexible fixed income strategies. While the macro environment remains supportive, elevated uncertainty and growing tail risks argue for dynamic positioning, disciplined risk management and a willingness to exploit volatility. By actively rotating across markets, curves and sectors, investors can better navigate an increasingly fragmented global landscape while seeking to preserve capital and enhance returns.

Figure 1: US 10-Year Treasury Yield