Valerio Baselli: Hello and welcome to Morningstar. Fixed-income investors are weighing the implications of cooling inflation, slowing growth, and shifting central bank policy. With 2026 shaping up to be a pivotal year for bonds, today I’m joined by Laura Cooper, head of macro strategy at Nuveen, to discuss the outlook for next year.
So, Laura, to begin, how do you expect the global macro environment to shape fixed-income markets in 2026? What factors will dominate?
Laura Cooper: Well, there are key themes that we think will shape the market for fixed income investors next year. The first is around really after a remarkable run in financial markets in 2025, we think that given high valuations, chasing index-like risk won’t have the same risk-reward profile that did in the past. So, investors will have to dig deeper for diversification. And this means giving up some liquidity rather than chasing credit risk, as well, we’re seeing this economic resilience prevail. And this is largely being underpinned by the US.
And so, we think that does warrant, you know, taking on still a risk-on posture heading into next year. So, taking on still up in quality but looking at sub investment grade indices. And then as for the final two themes, we think fiscal stimulus will actually matter more than monetary policy next year as central banks near the end of their easing cycles. And then developed markets need to take on the EM playbook. That’s another key theme, because we think a lot of the signals that have been attributed to emerging markets now apply instead to developed markets. And we’re seeing a blurring of lines between those two.
Will Central Banks Continue Cutting Interest Rates in 2026?
Baselli: Right. What is your base case for central bank policy, particularly the ECB and the Federal Reserve, in 2026? Are we entering a ‘new normal’ for interest rates?
Cooper: It’s a great question. After a period of global synchronized monetary policy, we think that central banks are now coming to the end of their cutting cycles. But we will see some divergence. So, the Fed we suspect will cut rates two more times over the next 12 months. And that’s largely reflective of a still-resilient economy, but as well inflation risks tilted to the upside. Whereas if we look to Europe, the ECB has assessed policy as being in a good place with the balance of risks really tilted more towards being neutral. And so, we think that warrants the ECB now ending their cutting cycle. And if anything, we’re a bit of an outlier in consensus and anticipating the European Central Bank could start to hike rates with one rate hike in our forecast by the end of next year.
Opportunities in the Bond Market
Baselli: Interesting. Now, from a European investor’s perspective, where do you see the biggest opportunities within the fixed-income space right now?
Cooper: I think we are still seeing a preference for US fixed income from European investors as we start to see those hedging costs come down. But really looking in more pockets of securitized credit and CLOs in some of those less traditional fixed income allocations, and as well emerging market debt is quite attractive. We’ve seen it outperform quite strongly this year, and we suspect that that can persist next year, including those local EMD exposures, given the further dollar depreciation. And when we look on a hedged basis for European-based investors, even though we’ve seen a narrowing of those spreads with EM, we are still seeing a favorable uptick relative to what those investors can get in more of those investment grade and high yield credit exposures in Europe.
Inflation-Linked Bonds Offer Security
Baselli: Okay. We mentioned inflation. How appealing are inflation-linked bonds today, in your view?
Cooper: Well, we think that inflation is an underappreciated risk by markets now heading into 2026. We still think there’s scope for inflationary pressures in the US to build on the back of earlier tariff announcements. And so, while inflation could ease somewhat next year, we still suspect it is going to be above 2%. So, I think inflation-linked exposures are an important element of portfolio allocation to hedge against some of those upside risks. And I think inflation importantly is really feeding into a key conviction view for us next year. And that’s around investors probably warranting higher term premium to compensate for some of the fiscal dynamics coming through in the US. So, it’s not chasing duration and really staying away from those long end exposures, in part due to those inflation pressures, potentially coming through.
The Biggest Risks for Bond Investors in 2026
Baselli: Finally, what are the biggest risks bond investors need to be aware of for next year?
Cooper: Well, certainly we’ve seen strong performance this year that has brought spreads quite narrow. Earlier this year, spreads were narrow in the most we’ve seen it in several decades. And so, we do suspect we are going to see some modest widening next year. But overall this is a backdrop of still US economic resilience, which we think should prevail, and not see an overall blowout of spreads. But that said, I think the risks largely stem, as I mentioned, from inflation as well as geopolitics. And then looking at those fiscal dynamics coming through, could investors, you know, focus their attention on that ‘one big beautiful bill’ implications and the rising deficit and staying away from some of those traditional government bond allocations and treasuries and instead looking to diversify and other alternative options and credit.
And then I would say the final risk is just around what comes through from the Federal Reserve. We have a shift in composition coming through next year. Markets are already positioning for a dovish regime shift. Looking at expectations for a rate cut next June. And we think that’s a tail risk that we’re going to see a challenge to central bank independence. But I think certainly a risk that’s worth for investors to monitor.
Baselli: Thank you so much, Laura, for your time. For Morningstar, I’m Valerio Baselli, thanks for watching.
