Quarterly fixed income review and outlook | Insight Investment

We believe global economic growth is stabilising overall, as the modestly positive PMIs, on average, suggest. However, activity is likely to remain below trend in developed markets, with emerging markets growing at a faster rate. Inflation remains stubbornly above target inflation in many places, but we do not anticipate a meaningful acceleration. A slow return to target levels is our base case, with the eurozone having already achieved that objective. Real rates are declining, but there are unlikely to be many further rate cuts from major developed market central banks, with only the Fed and BoE expected to ease again in 2026. We believe we are probably exiting a period of mid-cycle slowdown and the most likely forward path of growth is to eventually see some acceleration, though that may not be evident in data releases for a long time. We see this as supportive for risk assets generally but risks clearly remain. Fiscal positions are tenuous in many countries, which, if they deteriorate further, could put upward pressure on yields and slow growth. Geopolitical risks remain a central theme, with the Russia/Ukraine war still unresolved.

We anticipate the US will register further steady, if sub-trend growth, in 2026. The labour market is expected to continue softening, which could keep consumer expenditure under pressure, but real wage growth is likely to remain positive for the time being. The imposition of tariffs will likely depress imports more than the reverse effect on exports, which means the external sector will likely provide a positive impulse to US growth. Forward-looking indicators do not currently suggest an acceleration in manufacturing activity is likely but increasing amounts of AI-related infrastructure spending have been widely presented as a significant supportive influence on the US and global economy. Some risks remain that inflation may rebound but that is not our central case. We expect it to move broadly sideways but with some volatility, to end 2026 just below 3%. We believe the Fed will continue to reduce interest rates, reaching a terminal level of 3.25% sometime in the next 12 months. We expect 10-year, and 30-year Treasury yields to be close to current levels in 12 months’ time, at around 4.10% and 4.80% respectively, though volatility is possible, particularly as the midterm elections approach.

Though eurozone leading indicators have remained relatively resilient in the face of ongoing tariff uncertainty, we do expect export growth to be outstripped by import growth to hold GDP growth back close to 1%. The promised increase in German government spending on infrastructure and defence will offer some positive impetus and could provide potential upside surprise but Germany is still likely to be a laggard, compared to other countries such as Spain. Inflation is already close to the 2% target level, and it may ease further due to base effects. We see it edging slightly lower in the round, towards 1.7%. However, in the absence of other shocks to growth, demand, or prices, we expect the ECB to maintain rates at current levels. As France’s fiscal challenges remain largely unresolved, the size of the deficit means the political difficulties threatening the government are likely to resurface, particularly with the next presidential election due in 2027. We expect 10-year German government bond yields will be slightly lower than current levels 12 months ahead, at around 2.75%. However, increased borrowing at longer maturities could see 30-year yields rise to 3.5% as the curve steepens.

UK GDP is likely to see positive but below trend growth in 2026. The dampening influence that repeated leaks of potential budgetary tax measures had on business and consumer confidence in the autumn should fade and could lead a revival in near term fortunes for the UK economy as a whole. While the budget does not introduce immediate fiscal tightening, prior policy measures will continue to slow economic growth next year. Household confidence is still weak due to persistent inflation and anticipated tax hikes, which may limit discretionary spending. The budget may reduce inflation in 2026 but drive it higher subsequently. Since there are no fiscal policies driving inflation higher, we can expect a downward base effect on headline inflation in the spring. Lower energy bills and a rail fare freeze will likely reduce inflation by another 0.2%-0.3% in April. Combined with a slight slowdown in core goods inflation and food prices returning to normal after this year’s increases, headline inflation is anticipated to fall back toward the 2% target by mid-year. However, the measures will reduce inflation only for one year, before dropping out of the annual comparison. Fuel duty increases are scheduled from next September, which will then help push inflation higher. With the base rate now at 3.75%, we expect just one more rate cut from the BoE in 2026, while we see gilt yields remain fairly steady, with the 10-year at 4.5% in a year’s time. Longer yields may decline slightly, with the 30-year approaching 5%.

We continue to expect a modest deceleration in GDP growth in China to approximately 4% in 2026, as the domestic economy and the real estate sector struggles to accelerate. Investment spending may continue to improve, particularly in innovative technology, consumption is unlikely to do the same and government spending is not expected to provide much significant support. Net exports will likely become a drag on growth rather than a tailwind as the tariff effects continue to bite. We expect inflation to remain volatile but not to accelerate much, probably edging above 1% on average over the year ahead. The PBoC will likely primarily maintain a watching brief, with little if any changes to official rates. We believe that the current low levels of bond yields will gradually rise in time with the 10-year rate moving to 2% and higher in the course of the next 12 months.

In other emerging markets, where fiscal policies are not clear headwinds to growth, we see relatively robust domestic activity facing off against the effects of US tariffs on trade. Countries that have less reliance on the US as an export market may have better growth prospects. As with most developed market economies, inflation is expected to continue moderating slowly over time, though there may be volatility in that process. There is the potential for further interest rate cuts in many countries, particularly if USD weakness resumes and the Fed continues to reduce rates, although elevated inflation in Brazil may prevent significant easing there.

Recent corporate earnings have reaffirmed our view of the strong corporate fundamentals, underpinned by resilient profit growth. However, a notable theme across corporate results has been rising capital expenditure. We expect 2026 to be affected by borrowing for capital expenditure and merger and acquisition activity, driving a significant increase in issuance, most notably from AI-related expenditure. While this supply dynamic is now well telegraphed and is unlikely to surprise markets, we anticipate that spreads could continue to edge wider and settle into a higher trading range early in the year as corporates return to the market in size. If supply disappoints and investor demand remains high, then spreads should grind tighter. New issuance often comes to market with yields above prevailing levels. These types of primary market opportunities could benefit managers capable of active participation, which may help offset any effects of wider spreads. One trend that we’re closely monitoring is high-quality US corporates looking to issue euro-denominated debt seeking to take advantage of lower coupon rates. This may present opportunities for those with global mandates or flexibility to invest off benchmark. We believe investor demand will remain robust in 2026 as investment grade credit offers a meaningful yield pickup over cash, and in our view, spreads offer attractive returns when compared to fundamental default risks, so we expect demand to remain high, with a focus on security selection and relative value trades.

2025 was a strong year for high yield market performance, supported by a robust technical backdrop that we expect to persist into 2026. That said, we anticipate a pickup in supply across both US and European markets. While refinancing activity should dominate, we also see room for increased issuance linked to acquisitions and capital expenditure. In addition, AI infrastructure financing is likely to make its way into the high yield space in various forms. This rise in supply could exert some upward pressure on spreads, leading to slightly softer returns than seen in 2025. Default rates remain at the lower end of historical ranges, and we see little reason for this to change given the improving quality of public high yield issuers and the migration of weaker credits to private debt markets. Maintaining caution around highly leveraged cyclical names and keeping an underweight in CCC-rated credits should help further mitigate default
risk. Credit selection will remain critical, and we expect meaningful opportunities to add value via active security selection throughout the year.

We believe emerging market (EM) local rates markets in places such as Brazil and Colombia keep them attractive for the time being, although both markets are expected to endure election related volatility in 2026. We remain steadfastly constructive on EM corporates due to the confluence of macro forces that we expect will act as tailwinds. For example, the growth differential between EM and developed market (DM) economies is expected to remain favourable, global trade is not expected to deteriorate materially as the world gets used to the US tariff regime and dollar weakness continues. Inflows to the asset class ae also expected. Likewise, EM corporate fundamentals appear robust compared to DM corporates. Upgrades to earnings estimates are outpacing downgrades and default rates remain below the long-term average. EM corporates also benefitting from low net supply, which we expect to continue into 2026. EM high yield corporates, which we are overweight, are currently expressing high relative value. Currently underweight EM investment-grade corporates.

2025 delivered solid, primarily income-driven returns, and we expect a similar outcome in 2026. A gradual reduction in US and UK interest rates should provide support for consumers in those markets, though it will also temper returns given the floating-rate nature of the asset class. This dynamic reinforces the importance of credit selection to capture the best opportunities. We see particular potential in the UK, where markets appear overly pessimistic about consumer prospects following negative headlines around tax increases. With the budget now behind us, we anticipate sentiment will normalize in the months ahead. Our approach remains active in primary markets, taking advantage of new-issue premiums while seeking relative value opportunities that offer compelling risk-reward profiles. We continue to favour transactions with seniority in the capital structure and robust deal features that redirect cash flow in the event of
underperformance in the underlying asset pool. Strong underwriting and servicing standards should further help insulate investors should economic conditions weaken unexpectedly.

We see a broadly constructive outlook for municipal bonds in 2026, with taxable muni yields remaining attractive, in our view, versus similarly rated corporate credit. Credit fundamentals appear strong, supported by robust reserves and cash balances built up in recent years. With the economy expected to slow, we favour defensive sectors such as public power and water/sewer utilities for their essential nature and predictable cashflows, while maintaining an underweight in state and local general obligation bonds given their lower premium to Treasuries. We remain cautious on healthcare due to rising labour and equipment costs. Following significant curve steepening, we view the long end as compelling and prefer barbell strategies, combining short maturities to seek benefit from Fed easing with long maturities to capture the yield levels available. Although spreads are tight by historical standards, we believe they remain supported by solid credit fundamentals and steady investor demand.

We continue to monitor the diversification from USD to reserve currencies and gold. Global inflation is more bifurcated, developed market central banks are signalling a pause to cutting cycle, although the Fed and BoE are outliers. The temporary trade truce between the US and China, along with modest positive developments in geopolitics appearing to undercut upward pressure on oil prices. At a country/currency level, unsustainable US fiscal policy, growing risks to Fed independence, and other potential risk factors are likely to weigh on the USD. On the eurozone side, market will look at the effects that increased German fiscal spending could have on overall growth, alongside the political risks in France remaining high and acting as a drag on the EUR outlook. In Japan, the BoJ could require further wage data before committing to additional policy hikes, with JPY depreciation potentially forcing official intervention if momentum continues to diverge from fundamentals. Overall, we expect USD to depreciate due to rate cuts, faltering US growth relative to the rest of the world and pressure on Fed independence.