A move toward neutral rate policy sets the tone

Concerns about labor market strength prompted the Federal Open Market Committee (FOMC) to cut the federal funds rate by 50 basis points across its September and October meetings and announce a suspension of its balance sheet runoff.

While the FOMC still views the level of its policy rate as restrictive, our outlook heading into 2026 suggests financial conditions—namely financing, investing and spending—are now much closer to neutral than they were a year ago. Market-based forecasts anticipate a handful of additional cuts through 2026, likely bringing the policy rate toward 3% by year-end.

Exhibit 1: Fed projections and market-based expectations align well heading into 2026

Projections from the Federal Reserve as of September 17, 2025; market-based Fed fund futures as of November 22, 2025. Sources: Federal Reserve Summary of Economic Projection, Bloomberg

Uncertainty persists on both sides of the Fed’s dual mandate. Labor market softness contrasts with inflation that should ease somewhat as housing costs stabilize, although tariff-related price pressures remain a potential wild card. While we remain confident in the ultimate destination of FOMC rate policy, the path toward 3% may prove non-linear, with the Fed adjusting as we move throughout the year.

Changing of the guard at the Fed

Perhaps the most significant development for 2026 will be the leadership transition at the Fed. Chair Powell’s term ends in May, and while he may remain as a governor, most Chairs historically step down.

The Trump administration has been critical of recent rate policy and is expected to nominate a much more dovish successor. Though the Chair represents only one vote, the position’s influence is substantial and could tilt the FOMC toward a more dovish stance in the second half of 2026.

Longer maturities: Fairly valued, but sensitive to economic developments

Broader market interest rates appear fairly valued entering 2026 given Fed and economic expectations.  We also see a relatively stable environment for global interest rates as inflation continues to move toward central bank targets, tariff-related risks are better understood, and most developed market central banks appear to be near the end of their rate-cutting cycles.

Shorter maturities should continue to follow central bank monetary policy. This should allow rates in some global sovereign markets, like the U.S., to drift slightly lower as additional rate cuts are announced. Longer maturity rates appear fair, but they will remain sensitive to economic strength and inflation.

Labor markets are likely to continue softening modestly, with companies channeling more spending toward AI implementation than hiring. Restrictive immigration policy may further limit labor supply, while inflation uncertainty poses upward risk to rates.

Sluggish conditions in the housing market should help offset price pressures, but fiscal stimulus from the One Big Beautiful Bill Act and delayed tariff pass-throughs to consumers could keep inflation sticky. These crosscurrents suggest two-way risk for long-term yields in 2026.

Issuance and supply dynamics

Debt issuance will remain an important factor across sectors. Municipals saw back-to-back record issuance in 2024 and 2025, while investment-grade corporate issuance in 2025 will likely reach the second-highest level just short of the 2020 peak, though we expect another year of robust supply from both in 2026. Inflation, AI-related capital expenditures and other factors have driven borrowing to elevated levels, which have been supported by solid investor demand. Treasury issuance should also stay strong, likely concentrated in shorter maturities to avoid undue pressure on long-term yields and mortgage rates.

We expect investor demand for fixed income to remain robust given attractive absolute levels and falling cash yields. However, rising budget deficits or deteriorating credit fundamentals could leave market participants demanding higher compensation for those risks—leading to potentially higher yields and wider spreads for issuers.

Credit outlook: Fundamentals remain solid

Credit spreads remain near historically low levels against a backdrop of record bond issuance, suggesting strong fundamentals and solid market access. Corporate earnings growth and manageable debt service levels support this positive view, though we do not expect meaningful further spread tightening in 2026.

Exhibit 2: Credit spreads are still quite low in historical terms