Fixed Income Forward: July 2026

With oil-price risk easing, markets might logically have rotated back to the inflationary-boom narrative that opened the year. Credit spreads are likely to remain range-bound, anchored by persistent demand, meaning carry remains both the primary and most dependable source of fixed income returns. Corporate fundamentals remain solid: healthy balance sheets, resilient interest coverage and low default rates. Periodic stress is likely, especially in private credit due to refinancing, but the broader credit backdrop stays constructive.

In rates markets, market pricing has created opportunities to go selective long duration tactically. We doubt central banks will deliver the full tightening priced into markets unless inflation pressure broadens well beyond energy. Having rebuilt inflation-fighting credibility through the European Central Bank's hike, a more hawkish split at the Bank of England and the Fed's firmer stance on price stability, policymakers now have room to be patient. With energy prices cooling and inflation expectations anchored, urgency to hike has faded. Still, markets reprice quickly. Tactical dislocations can emerge and disappear within weeks, if not days. Capturing these opportunities requires more than a static asset allocation framework; it demands a fully active and flexible approach, capable of adjusting duration, relative value, country and sector exposure and risk positioning as market expectations evolve.

On the Fed, while markets read Warsh's debut committee meeting as hawkish, he has also pushed policy ambiguity further than before, paring the statement to its essentials and withholding his own dot-plot projections. This diminishes the information value of forward guidance and echoes the Greenspan era, when deliberately opaque communication let policymakers preserve flexibility. Rather than betting on the Fed's next move, we think portfolios should be positioned for a higher-for-longer rate environment where attractive all-in yields make resilient income the dominant fixed income objective again.

Taking a broad view, the macro constraints are unchanged: large US fiscal deficits, substantial Treasury financing needs and an economy reliant on strong asset prices. A more aggressive tightening cycle than markets expect looks unlikely, particularly with midterm elections coming soon. Meanwhile the bar for a dovish repricing looks low. A softer growth print, further easing of inflation or renewed optimism about AI could be enough to unwind hike expectations. So, while markets have embraced a more hawkish narrative, the greater risk is that further tightening gets priced out rather than in. If that happens, the dollar could lose momentum even though near-term positioning and trends still favour it. Our long-term view remains unchanged: the dollar ultimately needs to weaken to help correct its overvaluation and facilitate adjustment of the twin deficits.

In this environment, we think duration should be managed tactically rather than as a structural hedge. High-quality short-dated credit can offer a mix of income and downside resilience, while Chinese government bonds, the renminbi and select emerging market debt may offer diversification benefits. Under an inflationary backdrop, fixed income's defensive qualities can't be assumed. Defensiveness is now conditional and regime-dependent. The emphasis shifts from asset-class allocation to instrument selection, duration becomes tactical rather than structural, and coupon income and credit carry become the main shock absorbers. Diversification must be engineered across regions, sectors and risk factors.¹ Active management matters more than ever. Fixed income is becoming a dynamic toolkit rather than a passive diversifier, with income, duration, inflation sensitivity and alternative return sources each hedging different risks. Success will depend less on forecasting the Fed's next move and more on building portfolios resilient across a wide range of outcomes.