Market Talk: Bonds Face Challenging Year as Fiscal Policy Drives Yields Higher

Challenging Year for Bonds

• 🗓️ 2026 is anticipated to be a challenging year for bonds due to the end of synchronized monetary policy cycles across developed markets.
• 📈 Fiscal policy is expected to become more influential than monetary policy, with elevated deficits driving growth, inflation, and term premia.
• ⚠️ Investors are advised against chasing duration, particularly in the US, and are instead leaning into curve steepening to capture higher term premia.
• 📊 The market anticipates a structurally higher for longer backdrop for yields, making fixed income an attractive space overall.

Fed Independence and Reflationary Risks

• ❓ The Fed's independence remains a lingering concern for markets heading into the next year.
• 🏛️ While reappointments of regional Fed members have reduced some risk, a chair change in leadership could usher in a more dovish regime.
• 🔥 This potential dovish shift, combined with strong fiscal impulses, suggests the greatest risk is not a recession, but a reflationary environment with resilient growth and rising inflation.

Treasury Yields and AI Investment

• 📉 Despite Fed rate cuts, bond rallies have not materialized, with the 10-year Treasury yield expected to remain rangebound between 4-4.25%.
• 💡 AI-related financing is identified as a risk that could push up borrowing costs, though AI is also seen as a crucial pillar of US growth.
• 💰 The greatest risk-reward profiles are seen in credit and private markets for financing AI buildouts, including municipal bonds, utilities, and infrastructure debt.
• ⚡ The race for AI is increasingly becoming a race for capacity and power, necessitating grid upgrades.

European Asset Opportunities

• 🇪🇺 A structural reset of European assets is underway, with the German 10-year bond yield expected to be above 3% and the euro to be higher.
• 📈 Attractive carry opportunities can be found in the European periphery, such as Italy and Spain, where growth is robust.
• 🌐 Diversification across the globe is recommended, with opportunities in securitized products, senior loans, and CLOs, suggesting an ample opportunity set in 2026.