In brief
- Central bank policy divergence will be the defining feature for short-term rates in 2026, resulting in more two-way volatility and greater sensitivity to domestic data.
- Macro conditions remain broadly supportive, with monetary policy still biased toward easing in several major economies and fiscal policy remaining accommodative, even as geopolitical risks escalate.
- The Federal Reserve (Fed) is expected to maintain an easing bias, with one to two rate cuts possible later in the year, as sluggish employment, sticky inflation and geopolitical risks shape policy decisions.
- The European Central Bank (ECB) is likely to hold rates through 2026, though geopolitics could disrupt anticipated stability. In contrast, the Bank of England (BoE) appears positioned for gradual easing, but a divided committee may add volatility.
- Across APAC, policy paths are diverging with local economic conditions driving central bank decision-making as the Fed’s influence wanes and de-dollarization adds an additional layer of complexity for regional policymakers.
Supportive backdrop, sharper dispersion
Following a broadly synchronised monetary policy easing phase over the past few years as inflation retreated, central banks are beginning to chart different courses based on local rather than global macroeconomic conditions. We believe this divergence is likely to shape short-term rate behaviour through 2026, though geopolitical risks and economic data surprises could still push central bank off course.
Monetary policy in several major economies retains an easing bias, while fiscal policy remains supportive. In our view, this combination continues to underpin liquidity conditions. At the same time, the risk landscape is evolving. Geopolitical tensions, lingering trade worries, fiscal sustainability concerns and elevated corporate debt issuance may contribute to episodic volatility.
United States: easing bias and funding stability
We believe the Fed is likely to maintain an easing bias with one to two rate cuts possible later this year. Recent growth has softened, mainly due to the late-2025 government shutdown and severe winter weather conditions, while consumption remains resilient and labour conditions appear to be stabilising. Core PCE, the Fed’s preferred inflation gauge, remains above target at near 3%y/y, and up-side energy-related risks could influence the timing of further easing.
A leadership transition at the Federal Reserve adds an element of uncertainty; however, we believe it is important to emphasise that policy decisions remain committee-based across the Federal Open Market Committee.
Following late‑2025 volatility, funding conditions have steadied in 2026, aided by the Fed’s resumed Reserve Management Purchases to control overnight rates, reducing dislocation risks.
In an environment of stable yields and upward sloping yield curve, we believe active duration management remains appropriate in USD liquidity portfolios, balancing income preservation with flexibility should policy easing resume.
Europe and the UK: policy stability and gradual adjustments
In Europe, the ECB and the BOE are charting increasingly divergent paths. We believe the euro area economy remains relatively resilient, supported by labour markets, private sector balance sheets and public investment. The European Central Bank expects inflation to stabilise close to its 2% target and appears inclined to hold rates through 2026. As the ECB’s quantitative normalisation continues, excess reserves will decrease toward equilibrium levels, technical factors may influence money market spreads, compressing ESTR towards the deposit rate.
In the UK, growth remains subdued and the labour market is softening. With inflation projected to approach target in 2026, the Bank of England is set for gradual easing this year – contingent on incoming data. However, divisions within the Monetary Policy Committee on the pace and endpoint may add volatility to short tenor sterling rates.
In Euro liquidity portfolios, we believe a neutral duration stance remains appropriate given technical and policy crosscurrents. Sterling portfolios, may warrant a longer duration position, mindful of heightened sterling rates volatility.
APAC: differentiated regional dynamics
The Asia-Pacific economic outlook remains broadly positive, supported by easier monetary policy and strong exports demand. However, central bank policy paths are diverging as domestic economic emerge factors take precedent and the disinflation wave fades. The waning influence of Fed monetary policy and the impact of de-dollarization continues to add additional layers of complexity for regional policymakers.
In China, resilience exports are offset domestic weakness. Monetary policy remains dovish, but we believe but with dis-inflation fading and yields already low, the timing and size of further PBOC cuts is increasingly uncertain.
In Hong Kong liquidity flows and US Federal Reserve policy will continue to influence short-term rates. Meanwhile in Singapore, robust economic growth and firmer inflation have prompted investors to watch for potential policy tightening in 2026
In Australia, the RBA became the first major central bank to hike in 2026, raising the cash rate by 25 basis points to 3.85% in February. Persistent inflation and strong private demand forced the RBA to act to retain its credibility. We believe the key risk for investors is that inflation expectations stay elevated necessitating further policy action.
Finally, in Japan, inflation has remained above target for an extended period and fiscal policy is turning more expansionary. We believe further policy normalisation is possible, albeit at a slower pace.
Conclusion and implications for liquidity investors
We believe central bank divergence has replaced synchronised easing as the defining front-end theme for 2026. This shift is likely to result in more volatile short-term rate outcomes and sharper responses to local data and policy signals. While the overall policy bias in several major economies remains toward easing, geopolitical and fiscal risks warrant continued vigilance.
In this environment, we recommend a focus on liquidity and diversification - maintaining high-quality exposures, managing duration actively and stress-testing portfolios for policy and geopolitical uncertainty remain central to prudent liquidity management. Cash segmenting is also advisable: Operating balances may remain in money market strategies prioritising liquidity and capital preservation. More stable balances may consider selective extension into ultra-short strategies, subject to risk tolerance and liquidity needs.