• Developed economies are diverging in their monetary policy paths and this has several implications for fixed income markets.
  
  
• Attractive yields provide a solid foundation for investor returns, but tighter valuations make us more cautious about adding risk.
  
  
• In an environment of heightened volatility, we acknowledge that elevated starting yields enhance return potential but cannot fully shield portfolios from macro or market shocks.
   

Global rates markets are entering 2026 with a level of divergence not seen in over a decade. Economic growth trajectories, central bank policy paths and inflation dynamics are increasingly asynchronous across major economies. For active fixed income investors, this raises a central question: is divergence an opportunity - or an obstacle?

The implications of divergence

Across developed markets, monetary policy cycles are no longer moving in lockstep. Economies are responding at different speeds to post‑pandemic structural shifts, evolving supply‑side dynamics and domestic political backdrops. This is a pattern we expect to persist throughout 2026.

This has several implications for fixed income markets: higher dispersion in rate paths, potentially creating a richer opportunity set for cross‑market relative‑value positioning; increased sensitivity to data surprises, as even modest shifts in growth or inflation can meaningfully alter terminal rate expectations; and higher volatility, with markets increasingly repricing policy trajectories in real time.

High starting yields - but tight valuations

Yields across global markets remain elevated relative to recent history¹, providing a solid foundation for forward‑looking fixed income returns. That said, valuations have tightened meaningfully. While this is not, in itself, a catalyst for a market correction, it does create an environment in which we are more reluctant to add risk.

A large part of recent fixed income performance has already been driven by spread compression - as a result, carry remains attractive. Further, fixed income beta is unlikely to deliver the outsized returns seen in previous years, and security selection and relative‑value positioning will matter more than ever in driving returns.

Diverging dynamics across developed markets

In the US, looking beyond the policy headlines, data remain key, and the fundamentals tell a broadly upbeat story. We continue to see resilient levels of economic growth in the US, supported by sustained productivity gains.

Inflation is easing, though not yet at levels that would give policymakers confidence in a smooth and predictable path to rate cuts. As a result, markets have steadily pushed back expectations for the US Federal Reserve’s easing cycle.

Asymmetries and complicated signals

While the US economic narrative is one of robustness, other regions face more nuanced fundamental backdrops.

The euro area struggled with weaker growth last year, but some early green shots from increased German fiscal spending are starting to appear. Inflation has decelerated meaningfully, even reaching below 2% target at headline level. Yet, the path for the European Central Bank remains uncertain, reflecting an environment where incoming data can shift expectations quickly. Dispersion between core and peripheral economies adds an additional layer of complexity, while also creating fertile ground for relative‑value opportunities.

The UK continues to confront structurally slower growth alongside persistent inflationary pressures. Markets have swung between pricing in near-term rate cuts versus a more protracted period of loosening. This backdrop leaves UK rates highly sensitive to incoming data releases and shifts in political sentiment, complicating the interpretation of near‑term signals.

Meanwhile Japan represents the clearest case of policy divergence relative to developed market peers. After decades of ultra‑loose policy, the Bank of Japan is edging towards policy normalisation at a time when other central banks debate when, and how rapidly, to cut. This asymmetry raises the prospect of heightened volatility as Japanese yields reprice from historically low levels – but could also create compelling opportunities.

Divergence demands discipline

Divergence opens the door to mispricing and relative‑value opportunities, but it also demands discipline. Tight valuations, shifting data trends and rapidly evolving policy cycles require investors to balance carry with caution.

In an environment where thin valuation buffers and quick‑moving volatility can drive abrupt repricing, active fixed income managers can best extract incremental value by not relying heavily on directional risk, in our view.

For us, discipline in this environment means leaning into carry selectively, acknowledging that elevated starting yields enhance return potential but cannot fully shield portfolios from macro or market shocks – and exploiting divergence with precision, using cross‑market strategies where the risk‑reward profile is compelling. It also means being data‑driven rather than narrative‑driven, especially in the US, where fundamentals still offer the clearest signal.

This is a market that can reward active management, not through excessive directional calls, but through disciplined, research-led security selection that can harness dispersion without underestimating the risks.
 

¹ Source: Bloomberg, as at 19 January 2026. The Global Aggregate Bond Index yield was 3.5% as at 31 December 2025 versus 1.8% as at 31 December 2015 (local yields).

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