Fixed income returns are shaped by central bank policy expectations and, given the wide range of views within the FOMC, this raises both risk and opportunity for bond investors in the year ahead.

At the October Fed meeting, we saw this range of views clearly: one FOMC member dissented in favor of no rate cuts, while another dissented in favor of more aggressive easing. While policy disagreements are generally uncommon, this discord signals a committee wrestling with the balance between staying on hold or cutting rates further.

Why such a wide range of views? The divergence boils down to the Fed’s dual mandate: maximum employment and stable inflation. On one side, the hawkish camp views inflation as the more urgent challenge, with inflation hovering at 3% and tariff-driven inflation just becoming evident in the data. Moreover, if the Fed continues to cut rates while inflation remains above target, there may be an implicit assumption the committee is targeting a higher inflation rate – a notion that Chair Jerome Powell has overtly dismissed.

On the other end, low hiring rather than widespread layoffs likely only nudges the unemployment rate higher. Assuming more upward risk to inflation than unemployment, one might argue the Fed should focus more on inflation. In addition, there is, of course, political pressure from the administration on the committee to lower rates. While it’s unlikely Fed governors will vocally push back against the administration, a quiet, resolute stance defending Fed independence may be forming among a few members. That said, Powell’s term as Chair expires in May and Stephen Miran’s interim governor seat expires in January.¹ While both seats are likely to be filled by individuals that favor easier monetary policy, the long, staggered terms of Fed governors² shouldn’t materially alter the Fed’s path next year.

Given this, next year may see markets grappling with a more patient Fed than originally anticipated. At the time of writing, the market is pricing in roughly 80 basis points (bps) of rate cuts through 2026. Yet, as Powell recently stated, further adjustments are far from a foregone conclusion.

It is worth noting, as shown in Exhibit 2, that just as many Fed officials are concerned about the upside risk to inflation as they are to the upside risk to unemployment. Moreover, given the Fed is already near their estimate of “neutral” suggests more measured easing next year.

What does all this mean for fixed income in 2026?

1. As markets recalibrate rate cuts, be prepared for rate volatility. A dovish or hawkish pivot from the Fed could send yields lower or higher, respectively. As such, duration management will be key. We expect short rates (2-year Treasuries) will hover between 3.50%-3.75%, while long rates (10-year Treasuries) settle between 4.00%-4.50%. Therefore, balancing short-dated securities with select intermediate to long maturities provides adaptability if cuts stall or hikes re-enter the conversation.
2. Investors should embrace active management. Income in high-quality credits, securitized assets and municipal bonds remain attractive given solid corporate, household and municipal fundamentals, but selectivity is key. Moreover, if inflation does percolate, locking in attractive real yields via TIPS (and/or inflation-hedged assets like gold, commodities and private alternatives) may offer diversification from that risk.
3. Diversify across global bonds. It’s likely inflation uncertainty and debt levels will continue to rise in the United States, so other developed sovereign bonds may provide diversification against U.S.-specific risks, while emerging market debt continues to offer attractive carry (especially in local currency).

History shows that when inflation is a concern, the Fed tends to tread carefully – a pattern that may reassert itself in 2026. In short, fixed income investing is less about a big bet on the direction of interest rates and more about managing for a range of outcomes. This means active fixed income management, disciplined risk control and careful positioning are more important than ever.

¹ Stephen Miran can serve beyond January without another senate vote until a replacement is found.

² Each of the seven members of the Federal Reserve Board serve 14-year terms and are staggered so that one term expires every two years.

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