A clearer policy outlook in 2026 is pushing fixed-income investors back to fundamentals, with expectations of lower rates, a steeper yield curve and growing opportunities beyond the US, particularly in emerging markets.In 2026, we can really hit the ground running, as we now know the endgame on taxes and on some of the administration’s policies going forward. So, in fixed income, we are going to stick to our knitting. We are going to continue to review the fundamentals of companies before we even get to the valuation part. But key areas of interest for fixed income investors will continue to be the Federal Reserve and their policies.
We think under the current administration, it is far more likely that rates continue to go down, but the direction is known while the pace and timing is not. So, we look for the yield curve to move down from the very short end that is overnight all the way out to the 2-to-5-year space. But beyond that, it is not the Federal Reserve that controls the pace of rates in the US Treasury curve, it is the bond investors. And while I am not calling for the bond vigilantes to resume their occupancy of that long end of the curve and push it higher, they have been in slumber as of late, I am concerned about persistent inflation, debt in deficits, and interest costs that are consuming more and more of the administration and the government budget.
So, fixed income investors will be looking at a steepening curve, and perhaps wider spreads as we consider the outcomes of the policies that free up companies to make decisions. With that, again, winners and losers. And those winners and losers will come in the form of who uses AI better or best, but also in the form of M & A. All in all, we are expecting very steady and robust supply across fixed income markets, including in the tax-exempt municipal markets. So, for us, we are back to the basics of discerning value among all of the offerings that the market gives us.
Fixed-income investors also should look outside the US in 2026
As we look to 2026, we enter a time where we have more knowns than unknowns. The shifts in fiscal policy around the onset of the stimulatory assets of the United States Government’s One Big Beautiful Bill will come into the realm. Notably, many consumers will have money in their pocket in the form of higher distributions from their taxes. So, in turn, we expect consumers will spend.
For fixed income investors, some of these knowns that are coming out of those policy changes will lead to an environment of winners and losers. So, rather than simply sector shifts, we are looking at the dichotomy of some names that will work better than others. So, for fixed income investors, we see return to value investing. And one that is a mainstay of our approach rather than simply waiving in higher yields is to ask how are recent global economic trends impacting fixed income? Global economic trends at this time have really impacted fixed income by broadening the array of opportunities where we invest. We see very good signs of emerging market impact on portfolios, as well as on developing markets. We are viewing this as an increased opportunity set, as we have seen developed markets and emerging markets really evolve and broaden over time.
A fading US dollar is wind at the back of other economies. And it broadens our opportunity set as investors, and it gives us another way to find value and to potentially enhance returns in the portfolios. Across emerging markets, we have seen a discernible shift in that opportunity set over the past 15 years. And, so far this year, returns in that market have been extraordinarily favourable, compared to not only US markets, but other developed markets, as well. With China becoming a smaller part of emerging markets, as well as the reliance on the energy and gas sectors becoming smaller, we are seeing an opportunity set that is driven by many countries rather than just a few. These countries have developing economies now. They are not just stuck where they were 15 years ago. So, the yield opportunity is vast and that yield opportunity is now coming from the subset of emerging market companies that are regarded as investment grade. So, no longer can the investor confuse emerging markets with noninvestment grade rated debt. We are looking far beyond that in understanding truly the composition of that universe and the opportunity that it creates.
By Karen Manna, Vice President & Investment Director at Federated Hermes
