Rory Sandilands, Investment Manager at Aegon Asset Management looks at the prospects for fixed income markets and investment as we enter 2026.
Market resilience meets economic transition
Markets demonstrated remarkable resilience throughout 2025. Despite tariff policies, elevated geopolitical tensions, fiscal concerns and questions around institutional integrity, equities hovered near record highs while credit spreads tightened toward cyclical lows. Better than expected economic data, moderating inflation, a supportive central bank policy path and optimism around AI have all helped dampen volatility and fuel robust returns.
The 2026 economic outlook
Looking ahead to 2026, we anticipate moderate yet uneven economic growth, accompanied by a gradual, regionally divergent easing of policy rates. Credit markets are expected to remain range-bound, with valuations offering limited appeal. Investment grade spreads are close to cyclical tights, while high yield continues to offer income opportunities. However, the buffer against market shocks remains limited. In this environment, careful selection, thoughtful portfolio construction and precise curve positioning will matter more than broad market exposure.
US: Navigating the slowdown
The US economy is starting to slow. Private sector employment growth stalled in 2025 and outside of AI data centres, construction growth has flatlined. Further Fed rate cuts are anticipated in 2026, but the path ahead is far from predictable. Inflation has remained stubbornly above target, and the potential lagged effects of tariffs linger. The Fed faces an unenviable position of having to balance monetary policy between supporting the labour market and keeping inflation in check. We expect policy rates to reach at least 3.5%. The midterm elections may provide a policy pivot in the US, so this is a risk that can change the outlook.
Europe: Fiscal boost provides support
The European economy has shown signs of improvement, led in no small part by the fiscal boost of German infrastructure and defence spending. With inflation at target, the ECB has likely finished cutting rates this cycle. We don’t anticipate much change through 2026 although we will have one eye on the upcoming 2027 French Presidential election which will likely attract market attention in the second half of the year.
UK: Subdued growth, political uncertainty
UK growth will most likely remain subdued while unemployment rates edge higher. This will be a disinflationary force which will be welcome to the Bank of England, allowing them to move policy rates closer to 3%. Politics are never far from our minds. Local elections in May could trigger change at the top of government if Labour underperforms.
Positioning for multiple scenarios
In terms of positioning, the base case may call for more of the same, but clearly there are a multitude of paths that politics and the economy can take in 2026. We will be alert to embracing these risks but managing them effectively.
Fixed Income: Government bonds
Government bond markets will have an important role to play in 2026. We expect short-end rates to be well anchored, providing some degree of stability. We expect longer-end rates (10y +) to be more volatile given shifting supply and demand dynamics as fiscal largesse continues.
Credit markets: Balancing risk and reward
Demand for credit, attracted by higher all-in yields coupled with a lower policy rate path and robust investment grade corporate fundamentals, were a clear tailwind for credit spreads through 2025. Looking ahead, lower funding costs and buoyant equity markets are likely to encourage higher volumes of mergers and acquisitions, which in turn has the potential to weaken balance sheets and drive greater volatility and dispersion within credit markets.
AI-related capex and increasing M&A will help fuel record investment-grade corporate supply in 2026.
Managing idiosyncratic risk
The second half of 2025 has seen an increase in instances of idiosyncratic risk emanating from private credit markets and elsewhere, driving bouts of spread volatility. While relatively contained to date, such late cycle risks remain top of mind given the lack of spread cushion and potentially moderating supply/demand imbalance. Faltering confidence in AI-related equity valuations and resurgent inflation, while not our base case, are two further risks worth monitoring.
The bottom line
With these risks in mind, we maintain a preference for short to intermediate duration bonds, where breakeven characteristics are more attractive. Within high yield, BB/B-rated credits are favoured over lower-rated exposures. While spread curves have steepened slightly, they remain relatively flat and fail to provide adequate compensation for risk.
We expect 2026 to be defined by range-bound credit spreads punctuated with bouts of volatility, making selective positioning and disciplined portfolio construction critical to performance.
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