I always start the new year with a fresh notebook – and with the goal of asking the right questions For me, the start of the year isn’t just about reviewing what markets have priced in—it’s about anticipating what comes next. I often emphasises that successful investing means looking beyond consensus and preparing for catalysts that could reshape the narrative.

Which unpredictable forces could disrupt current market theses: U.S. reflation, challenges to fiscal expansion, disruptions to AI optimism or a pushback against market expectations for a 3% neutral rate in the U.S. These aren’t just hypotheticals—they’re scenarios that could redefine risk and opportunity.

Investors continue to face a range of market-related and economic challenges, including political uncertainty, persistent inflation, high budget deficits and ongoing geopolitical tensions. These factors can lead to volatility and make navigation difficult, but the good news is that investors can potentially earn solid returns with all-in bonds yields still highly attractive. With central bankers still highly data dependent, the threat of volatility spikes looms as we head into 2026. This backdrop makes it crucial to maintain a diversified allocation across fixed income asset classes, regions and sectors, alongside a highly active approach to duration management.

Risks Reflation

We are focusing on three key macroeconomic drivers heading into 2026; underappreciated U.S. inflation risks, fiscal sustainability and the supportive environment for credit.

Whilst 2025 was the year of rate cuts in the U.S., we expect 2026 to disappoint those expecting further easing. We see the combination of resilient growth, loosening fiscal policy, tariffs and a weaker dollar increasing inflationary pressures and pushing back on the Federal Reserve’s ability to ease policy.

Meanwhile, expansionary fiscal policy in the U.S., the UK, and some eurozone countries—notably Germany and France—is forcing developed market governments to fund deficit spending by issuing new debt. This raises questions about the long‑run sustainability of their debt and forces governments to offer higher yields.

And while credit spreads at near‑record narrow levels received much of the attention in 2025, we think there will still be credit market opportunities in 2026. However, elevated valuations will make strong credit selection essential. From a credit quality perspective, we don’t see many particularly concerning trends in fundamentals—issuer balance sheets are still solid, capital markets access remains robust, and we anticipate that default rates will stay below long‑term averages. That being said, there have been some “later cycle” credit behaviours that heighten the value of credit selection.

Actively Managing Duration 

Our approach deliberately focuses on a broadly diversified, globally oriented allocation across various bond classes. Given the combination of strong growth and accompanying inflation risks, we are overweight credit and underweight duration heading into 2026. This is primarily led by the U.S., where we see inflation risks most prominent, but we are also underweight Japan and the eurozone, given monetary (Japan) and fiscal (eurozone) pressures. However we are seeing a divergence across regions with growth rates varying and fiscal sustainability being taken more (or less!) seriously than others.

We are also finding opportunities through inflation protected bonds in the U.S. as well as select opportunities in emerging market nominal government bonds—the Czech Republic, Thailand, and Latin American nations like Brazil and Chile stand out to us. This environment underpins the need for an active and diversified approach to country allocations.

Meanwhile within credit, we like U.S. high yield given our constructive view on growth, and prefer consumer cyclicals with loosening policy set to support the consumer. The risks to our constructive outlook for credit include spreads that could widen quickly in the unlikely event that the economy slips into recession. 

Broadly, a global multi‑sector bond approach has the ability to find attractive income opportunities across a wide variety of fixed income sectors across the capital structure, including government and corporate bonds as well as securitized debt within both developed and emerging markets. The approach offers the potential to diversify return sources, which may appeal to investors seeking a more stable return and lower volatility through diversification. The ability to invest across a broad range of sectors and tactically adjust allocations to the market environment may be valued by an investor who is uncertain about what sector to buy or when to make a reallocation decision.

Ken Orchard, Head of International Fixed Income at T. Rowe Price.