Fixed-income investors face falling rates, tight spreads and a fragile labour market. The playbook requires locking in yield and managing duration, while staying vigilant on credit quality.
Prospects for bonds in 2026 look strong, but not without hurdles. With proactive rate cuts by the US Federal Reserve (Fed), resilient corporate fundamentals and continued investor appetite for fixed income, conditions support compelling returns. Still, a weakening labour market and tight credit spreads present potential challenges. We see 2026 shaping up to a year where investors can find value by locking in yield, managing duration and focusing on diversification – while keeping a close eye on credit quality.
Positioning for proactive Fed rate cuts
We are in an environment where the Fed is proactively cutting rates to remove the risk of negative outcomes, not in reaction to a crisis (ie, recession). The market is currently pricing in a sequence of cuts totalling 75-100 basis points (bps) in 2025 and an additional 75bps in 2026. This suggests the market expects an aggressive cycle of rate cuts, which would be a significant departure from historical norms outside of a recession (see Figure 1).
To deliver this level of easing, the Fed would require further evidence of labour market deterioration, and this evidence will need to arrive relatively soon. It also requires the Fed to look through (overlook) any direct and secondary effects of tariffs on inflation, the acceleration in private sector capital spending, the easing of financial conditions and the positive fiscal impact of the One Big Beautiful Bill Act.
We believe this scenario is unlikely, which suggests the front end of the Treasury curve is mispriced – creating an opportunity for investors. And unlike previous cycles, where rate cuts steepened the yield curve, today’s cuts are likely to keep the curve stable or slightly flatter. This creates three implications for fixed-income portfolios:
- Duration becomes attractive. It offers both more yield and downside protection against equity market drawdowns, especially relative to cash.
- Income harvesting. Investors can capture elevated starting yields without needing to take a directional bet on the economy.
- Diversification. High-quality fixed income provides a buffer, particularly in an environment where inflation remains (relatively) subdued.
Figure 1: Fed easing cycles since 1990
Source: Bloomberg LP and Columbia Threadneedle Investments. Data as of 31 October 2025. Gray rows represent recession.
Our playbook: Finding value with falling rates, tight spreads and strong fundamentals
The tension between labour market softness and ongoing economic growth will define the bond market’s path in 2026. We believe three scenarios could play out:
Source: Columbia Threadneedle Investments. For illustrative purposes only.
In our base case scenario, with 10-year Treasury yields around 4% and investment-grade credit yielding near 5%, bonds present a compelling value proposition, especially with inflation at around 3% (Figure 2). In this environment, investors should prioritize sectors offering higher yield per unit of duration.
Figure 2. The real yield on high-quality bonds remains attractive
Bloomberg corporate yield net CPI year-on-year inflation (%)
Source: Bloomberg LP. Data as of 30 October 2025. Corporate yield is represented by the Bloomberg Corporate yield-to-worst index, which tracks the YTW of the US investment grade corporate bond market.
These factors point to specific areas of opportunity within fixed income:
- Consumer loans. Asset-based finance stands out as an area of value. Backed by healthy household balance sheets and secured with collateral, consumer-oriented bonds offer diversification away from traditional corporate credit.
- Investment grade. Fundamentals are solid, but elevated prices make corporate bonds less compelling due to the risk of spread widening. For institutional investors, they remain an important asset class for liability matching. Agency mortgage-backed securities offer investment-grade quality at a better value.
- Artificial intelligence (AI). The massive buildout of AI infrastructure is reshaping credit markets, creating new opportunities for bond investors through innovative funding structures and increased capital demand.
- International bonds. Non-US growth may begin to look more attractive, with steeper yield curves offering additional risk premium in markets like Japan, France and Australia. There are pockets of value in emerging market debt.
- Leveraged loans. This is a contrarian call, given tight spreads and falling rates. However, they are not as expensive as other sectors and have matured into a through-the-cycle product, extending the high-yield opportunity set.
At the same time, we remain relatively risk-averse in sectors where we think we are not compensated enough for risk.
Managing portfolio risk in a tight credit environment
There are growing downside risks to the “steady as you go” outlook for 2026:
- Credit dispersion. Recent high-profile defaults were issuer-specific, reflecting weakness at the bottom end of both household and corporate borrowers. Importantly, we are not seeing that weakness spread. Instead, the real story is dispersion: After several years of monitoring, we are now seeing meaningful differences in credit performance across sectors and issuers.
- Tariffs. Another potential risk is tariffs. While the economic reaction has been muted so far, the effects may be working through inventories slowly and could hit consumers more forcefully in 2026.
- Credit volatility. Investors should also be prepared for volatility in spreads as the cycle matures. Focus on real risks – labour market trends, consumer stress and tariff impacts –while tuning out the noise. This is when and where fundamental credit research shines.
- Policy and politics. Policy-related noise has been intense and is expected to remain so in 2026. However, investors should keep in mind that this has limited influence on the actual performance of fixed=income markets. Demand for US fixed income continues to be strong, as many policy themes have not significantly impacted market dynamics.
The bottom line
In 2026, we believe the bond market will continue to offer value and opportunity – but not without risk. The Fed’s pre-emptive cuts, stable macroeconomic backdrop and healthy demand for fixed income set the stage for constructive returns. Yet, vigilance is warranted as labour market stress and credit events could become more pronounced. By focusing on duration, yield and diversification, investors can position portfolios to weather volatility and capture opportunity in a changing landscape.
