In recent weeks, UK assets have not been especially sensitive to Westminster drama in isolation; rather, gilts and sterling have been driven more by growth concerns, energy prices, and resultant expectations for Bank of England (BOE) policy. Because Starmer was already widely expected to lose any leadership contest, his resignation is unlikely on its own to trigger a large repricing. The bigger question is whether Burnham has the capability to catalyse a turnaround in the weak UK growth outlook without further deteriorating the country’s fiscal balance.

Burnham is generally seen as more comfortable than Starmer with an activist domestic agenda, particularly around housing, regional investment, infrastructure, and industrial policy. Burnham’s natural inclination is also to spend more, but that would need to be financed primarily by higher taxes, given he has expressed his commitment to abiding by current fiscal rules. Such a redistributive goal could shift the tone of UK policy debate and create more differentiation across domestically exposed sectors. However, it seems inevitable that any new prime minister would remain bounded by the same constraints that have challenged predecessors: limited fiscal room, high borrowing needs, and the prospect of strong market discipline. In other words, a Burnham premiership could change policy emphasis more easily than it changes the underlying UK macro constraints or direction.

This point is especially important in the current environment. We recently argued that markets may be overestimating how much the BOE will need to tighten in response to the energy shock. Indeed, the tentative agreement between the United States and Iran to end the war may eventually put downward pressure on energy prices. In any case, for the United Kingdom, higher energy prices look more likely to weaken growth than to generate broad, persistent inflation pressure. Labour market conditions have softened, wage growth is becoming less threatening, and second-round inflation risks are less likely to emerge as a result. That suggests the main macro story for UK markets remains one of weaker activity and potentially less BOE tightening than currently priced.

If Burnham were to raise doubts about fiscal discipline, gilt yields could come under renewed pressure and sterling could weaken. Absent a clear signal of fiscal slippage, we believe UK bonds still appear cheap compared to the most likely macro paths. This continues to support the case for UK gilts on a relative value basis versus global government bonds for UK-based investors. In equities, any impact is likely to be more sector-specific, with domestic and regulated industries more exposed to changes in policy tone than large multinational businesses.

For investors then, Starmer’s resignation is best understood as the expected formalisation of a transition rather than the start of a new market regime. The key question now is whether a Burnham government would risk undermining the United Kingdom’s budgetary credibility by materially loosening fiscal policy to pursue his economic agenda. We doubt the new government will be so bold, and is unlikely to seriously test the market’s willingness to impose fiscal discipline. Instead, macro and geopolitical forces still look more important than political considerations for the direction of UK assets.

The post Starmer’s Resignation as UK PM Sees Focus Shift to Burnham’s Fiscal Stance appeared first on Cambridge Associates.

Those concerns have grown in Trump’s second term amid repeated calls for lower rates and efforts to remove Fed officials. Even so, we see limited risk of a meaningful erosion in Fed independence. Legal and institutional safeguards still constrain political influence, and policy should remain driven mainly by inflation, labor market, and growth data. Continuity on the current board, whose members have a long record of voting independently, further limits tail risk, especially with Powell expected to temporarily remain a governor after his term as chair ends.

Warsh’s appointment is unlikely to drive a major near-term policy shift. In Senate testimony, he said he is “not pre-committed” to any course of action, and the Iran War has reinforced a wait-and-see stance by adding uncertainty around energy prices and inflation. Markets have also sharply repriced the Fed outlook for 2026, moving from near certainty of at least one cut and high odds of two to no cuts priced at all, with investors now split between the Fed staying on hold or hiking once. The latest dot plot still points to an easing bias, with two cuts penciled in through the end of 2027, but three dissents highlighted growing disagreement over the path forward and the chair’s role in forging consensus.

The bigger question is how far Warsh reshapes Fed strategy over time. He has called for changes to forward guidance, balance sheet policy, and the inflation framework. Some of these views diverge from the Fed’s current direction, particularly as policymakers appear inclined to slow and eventually end quantitative tightening as reserve balances approach ample levels, in part to reduce the risk of renewed funding-market stress, as seen in 2018–19. Warsh has also pointed to more stable inflation measures and artificial intelligence–driven productivity gains as reasons price pressures may prove less persistent than headline data suggest. Still, any major shift would require broad committee support and depend on the economy he inherits.

Market reaction so far has been limited, as the appointment has been overshadowed by broader macroeconomic and geopolitical developments. The bigger risk is not an outright loss of Fed independence, but that investors begin to demand a higher premium for policy uncertainty or price in greater tolerance for inflation at the margin. Over time, that could lift inflation expectations modestly, steepen the yield curve, and weigh on the US dollar, strengthening the case for diversifying away from concentrated US dollar and equity exposure.

The post The Economy, Not Kevin Warsh, Will Drive Fed Policy appeared first on Cambridge Associates.

Betting markets see Starmer as being very likely (between 70% and 80% odds of being gone by year end) to lose any such leadership contest. However, any successor would likely still have limited political capital to pursue regulatory, public sector, or welfare reforms that could materially improve growth. As such, the weakness in gilts earlier this week reflected expectations that a new Labour Party leader may lean towards some degree of fiscal easing. Expectations differ by possible candidate, with Angela Rayner and Andy Burnham seen as most dovish, while Wes Streeting is viewed as less likely to deviate from current policy. Whoever wins, one indication of their fiscal intent will be whether current Chancellor Rachel Reeves retains her post, given she is now seen as a defender of current fiscal rules. The timing of any resolution remains uncertain. If Starmer were to resign and support quickly coalesced around a single candidate, the process could conclude relatively swiftly. A multi-candidate contest, however, could run until September, ahead of the Labour Party conference.

Certainly, the longer the contest drags on, the more disruptive it will be for the economy and markets. The uncertainty by itself may be enough to keep some upward pressure on UK bond yields. Nonetheless, we do not think that these risks materially alter the bigger-picture relative value proposition that has emerged in gilts for UK-based investors. In the first instance, substantial fiscal easing looks unlikely, in part because of the discipline the market has imposed on the government since the Truss/Kwarteng budget. Any major fiscal changes are more likely to be redistributive than expansionary. Even prior to this episode and the current energy price spike, gilts were trading materially cheap in our fair-value model based on economic fundamentals, with a much greater risk premium priced in than peers. Furthermore, as has been the case over the past two months, energy price dynamics will continue to dominate the short-run direction of travel for yields. We expect weaker domestic activity and labour market dynamics to limit the extent of inflationary pressures broadening beyond energy and food, which takes some hiking pressure off the BOE. While a decisive shift towards fiscal easing, such as abandoning current fiscal rules, is a risk, that is not our base case. Instead, we continue to expect gilts to outperform peers over a three-year horizon.

The post UK Political Turmoil Adds Noise, But Gilts Will Remain Driven By Broader Macro Forces appeared first on Cambridge Associates.

At the same time, effective portfolio construction in this segment of the portfolio should still balance tax-efficient income with broader objectives, including liquidity, downside protection, and diversified sources of return. In that context, some families with acute liquidity or spending needs may still benefit from modest exposure to cash or taxable fixed income, while selected diversifying strategies, including certain hedge fund strategies, can complement munis and support stronger after-tax portfolio resilience.

Why some US private families have soured on munis

Historically, munis have delivered stronger after-tax returns than comparable taxable bonds, making them a core fixed income allocation for high-net-worth US private families (Figure 1). Most US private families have long allocated the majority, if not all, of their fixed income exposure to munis, though some have maintained modest positions in taxable alternatives such as cash, US Treasury securities, and investment-grade credit.

In recent years, however, several structural headwinds have challenged that position. Relative to larger segments of the investment-grade bond universe, particularly the US Treasury market, the muni market is smaller and less liquid, with a larger retail investor base. As a result, munis have at times been more vulnerable to liquidity squeezes and sharper bouts of volatility during periods of market stress. During the COVID-driven sell-off in early 2020, for example, some investors were forced to sell at a discount, crystallizing losses at an inopportune moment.

Meanwhile, persistently low yields in the years following the Global Financial Crisis (GFC) reduced the relative tax advantage of munis. More recently, the sharp rise in bond yields and the return of positive stock-bond correlations weakened fixed income performance more broadly and reduced its effectiveness as a diversifier. Together, these developments made it understandable that some families reduced their overall fixed income exposure and shifted a portion of their remaining allocations away from munis.

Cambridge Associates’ data suggest this shift has been meaningful. The median US private family client held nearly 90% of fixed income and cash assets in munis in 2015; by 2025, that figure had fallen to below 70%.

Why munis are regaining their edge

With the benefit of hindsight, reducing muni exposure was a defensible decision. The past five years were unusually challenging for munis, with low starting yields, rising interest rates, and elevated volatility weighing on returns. Over this period, munis returned 0.8%, significantly outperforming Treasuries at -1.8% but trailing cash at 1.8% after taxes, despite considerably higher volatility. Some alternative strategies, including certain hedge funds, also delivered stronger after-tax outcomes. The subset of hedge funds we view as most investable outperformed munis by nearly 400 basis points (bps) per year after taxes and net of fees.

Today, the environment is more favorable. Higher yields have improved return prospects across fixed income and provide a larger cushion against future volatility than investors had in recent years. They have also significantly increased the tax advantage of munis. As yields rise, the value of the tax exemption increases, resulting in greater tax savings for US private families in high tax brackets (Figure 2).

The Bloomberg Municipal Bond Index currently yields 3.8%, translating to a taxable-equivalent yield (TEY) of 6.0% for top-bracket US private families, which are well above levels seen for most of the past decade and higher than comparable taxable bonds. On a pre-tax basis, muni yields may not appear especially compelling relative to taxable bonds by historical standards. After adjusting for taxes, however, the value proposition improves. The TEY spread versus the Bloomberg Aggregate Bond Index is currently 140 bps, in the 85th percentile of the past ten years (Figure 3). Historically, higher TEY spreads have been associated with stronger after-tax excess returns for munis.

These elevated TEY spreads come even as sector credit fundamentals remain strong. State and local governments maintain healthy balance sheets, revenues continue to outpace expenditures, rainy-day fund balances are near record highs, and public pension funding ratios have improved for a third consecutive year (Figure 4). The expiration of COVID-era federal support and new federal policy changes present emerging headwinds, particularly for sectors such as hospitals and higher education. Even so, the broader municipal credit backdrop remains solid.

Reduced federal support is also contributing to higher issuance, and supply is likely to remain elevated as municipalities continue to fund capital needs. Attractive after-tax yields, sound fundamentals, and a healthy macro backdrop should nevertheless support healthy retail demand. Inflows into muni separately managed accounts (SMAs), mutual funds, and exchange-traded funds (ETFs) accelerated in 2025, and the market appears well positioned to absorb additional supply (Figure 5).

Recent events provide an early test of that thesis. The Iran War has weighed on risk assets and pressured fixed income, echoing some of the dynamics seen in 2022, albeit on a smaller scale. So far, munis have held up relatively well compared to Treasury securities. While near-term risks remain elevated, the medium-term case for munis to play a larger role in after-tax portfolio resilience remains intact.

How munis fit within a broader diversification strategy

Munis should remain the core holding for US private families within the portion of the portfolio intended to diversify equity risk. With yields higher and the tax advantage of munis more meaningful again, the case for allocating more to less tax-efficient alternatives has weakened. While those assets can still play narrower complementary roles in some cases, the tax cost of holding them should carry greater weight in portfolio construction than it did in recent years. For those that reduced muni exposure, the case for rebuilding it has become materially stronger.

Figure 6 compares munis with a range of less tax-efficient alternatives, including US cash, US Treasury securities, and hedge funds. It plots volatility on the x-axis and both pre- and after-tax returns on the y-axis over the past five and 30 years to show how the return, risk, and tax trade-offs among these assets have shifted over time. Over the past five years, the tax cost of moving away from munis was not especially meaningful in the context of the broader return and risk environment: cash and many hedge fund strategies held up better after taxes, while US Treasury securities performed worse than munis even on a pre-tax basis. However, that period appears more unusual than representative. Over the past 30 years, munis delivered approximately 4.2% after taxes, outperforming cash at 1.3%, Treasuries at 1.9%, and even a broad hedge fund index at 3.1%, while doing so with much lower volatility than hedge funds. The key exception is a carefully selected group of hedge fund managers capable of generating persistent after-tax alpha. The median performance of the subset of hedge funds we view as most investable has exceeded muni returns by 135 bps per year after taxes over the past 30 years, net of fees.

Taken together, this analysis suggests US private families should maintain a higher bar for shifting too much away from munis, given higher-than-expected after-tax returns prospects. This does not mean less tax-efficient alternatives no longer have a role. Cash, Treasuries, and other high-quality taxable bonds may still be appropriate for some US private families with near-term liquidity or spending needs, particularly because cash and Treasuries have been more resilient in some periods of market stress (Figure 7). But periods when munis underperform Treasuries have typically been relatively modest and/or brief, with the notable exception of the GFC, and US private families should not underestimate the cumulative tax drag of holding those assets over time. In many cases, a leaner cash position paired with access to a line of credit may offer a more tax-efficient way to preserve flexibility while maintaining meaningful muni exposure.

Selected hedge fund strategies have a stronger case than other less tax-efficient alternatives because they can provide differentiated return streams and, in some environments, greater resilience when traditional fixed income is under pressure, as seen in 2022 and in more recent, less severe equity market corrections. Even so, the hurdle remains high: these strategies should complement, rather than replace, meaningful muni exposure and are most compelling when implemented through carefully selected managers with a demonstrated ability to generate persistent after-tax alpha. ¹ This aligns with our previous advice to build exposure across a range of diversifier strategies—a principle that remains relevant, since no single strategy performs well across all environments.

Conclusion

We believe US private families should continue to anchor the portion of the portfolio intended to diversify equity risk with munis, while being more selective about allocations to cash, Treasuries, and other taxable fixed income, given the shift in after-tax trade-offs. Selected hedge fund strategies also remain an attractive complement to fixed income today, particularly when accessed through managers with a demonstrated ability to generate persistent after-tax alpha. For US private families that have drifted away from munis in recent years, the after-tax math has shifted decisively back in their favor. Now is the time to reassess and, in many cases, rebuild exposure.

Drew Boyer also contributed to this publication.

Footnotes

1. Identifying tax-efficient fund structures is a critical component of manager selection, as the after-tax return differential between tax-efficient and tax-inefficient hedge funds can be substantial.

The post US Private Families Should Revisit How Munis Fit Within a Broader Diversification Strategy appeared first on Cambridge Associates.

Though March’s roughly 60% rise in both front-month Brent crude oil and Dutch TTF natural gas futures has been substantial, monetary policy is poorly suited for offsetting an exogenous energy shock. Its main role is to influence domestically driven demand and, thereby, medium-term inflation. Tightening would be warranted if central banks judged that higher energy prices were generating second-round effects through wages, inflation expectations, and core inflation. But higher energy prices are already acting to slow demand by squeezing real incomes, raising business costs, tightening financial conditions, and weakening sentiment. Without clear evidence of those second-round effects, aggressive tightening would mean responding to a supply shock by further weakening already-fragile economies. That, in turn, would increase the risk that central banks are forced to reverse course later as growth and financial conditions deteriorate more than expected.

That logic applies to both the ECB and the BOE, though their starting points differ. In the United Kingdom, despite inflation remaining above target, economic slack has increased in recent months, as reflected in sluggish growth and a softening labour market. In the euro area, inflation had already returned to target and there were tentative signs of an activity recovery before the conflict began. The euro area also appears to retain a somewhat greater scope for a fiscal response than the United Kingdom.

The current situation also differs in meaningful ways from the shock that followed Russia’s invasion of Ukraine. That post-COVID episode was characterised by widespread supply-side disruption, including shipping bottlenecks, labour shortages, and semiconductor scarcity. Demand was also surging as lockdowns ended, supported by unusually strong fiscal stimulus. As a result, inflation was already far higher, standing above 5% in both regions. Labour markets were also materially tighter, with vacancy rates and wage growth both higher and still rising. The contrast between then and now is particularly stark in the United Kingdom. The unemployment rate has been trending higher for most of the past two years, while wage growth has largely normalised. That weaker UK backdrop is one factor behind our preference to moderately overweight UK gilts relative to global government bonds. With growth already soft and potentially deteriorating further and labour market slack continuing to build, the BOE is less likely to validate current market pricing. Gilt yields also remain attractive relative to our estimate of fair value and to yields in broader developed markets peers.

That said, the experience of the Ukraine shock helps explain why both central banks have an incentive to sound hawkish while uncertainty remains high. Emphasising the possibility of further tightening can help restrain inflation expectations and tighten financial conditions at the margin without requiring immediate action. That incentive is particularly strong given lingering memories of having fallen behind the curve in 2022. What matters most is whether there are signs that price pressures are broadening or that medium-term inflation expectations are beginning to drift materially higher. So far, that does not appear to be the dominant signal. For the ECB in particular, history should also reinforce the case for caution in tightening too rapidly in response to an energy price shock. The ECB’s rate hikes in 2008 and 2011 are now widely seen as examples of tightening into commodity-driven inflation shocks just as growth was deteriorating. Today’s policymakers are unlikely to want to repeat those mistakes mechanically. At the same time, they will not want to appear complacent after underestimating inflation persistence earlier in the decade. That tension argues for a middle path: a hawkish posture, and possibly some delivered tightening, but less follow-through than markets are currently pricing.

This view would be wrong if the current shock proves materially more severe or enduring. A persistent, significant impairment of energy flows is not our base case due to both the economic and political incentives faced by the parties involved. Nonetheless, we must recognise that a deeper or longer-lasting disruption to energy supplies could keep oil and gas prices elevated for long enough to generate the second-round effects central banks are most concerned about. In this regard, there is event risk around Tuesday evening’s US-imposed deadline for Iran to reopen the Strait of Hormuz, with further escalation a possibility. If higher energy costs begin to feed clearly into firms’ pricing decisions, wage-setting processes, and, ultimately, core inflation, the policy trade-off would shift. In that scenario, the supply shock would begin to resemble a more entrenched inflation problem, reducing the scope for central banks to look through the initial rise in headline prices.

For now, because we expect this episode to be primarily a growth-damaging supply shock rather than a fresh, demand-led inflation cycle, we believe markets are pricing in more tightening than the ECB and the BOE are likely to deliver.

Footnotes

1. Identifying tax-efficient fund structures is a critical component of manager selection, as the after-tax return differential between tax-efficient and tax-inefficient hedge funds can be substantial.

The post Will the Iran War Force the ECB and BOE to Tighten as Much as Markets Expect? appeared first on Cambridge Associates.

The election results represent a resounding win for Takaichi, with the LDP alone winning a two-thirds supermajority in the Lower House. Together with their coalition partner, the Japan Innovation Party (JIP), Takaichi now effectively controls 76% of Lower House seats. While the LDP does not have a majority in both houses, the Lower House supermajority enables the LDP/JIP coalition to override any opposition from the Upper House.

Takaichi secured the election by pledging decisive leadership and a vision for a more self-sufficient and assertive Japan, while also addressing the country’s cost of living crisis. Opinion polls consistently indicate that inflation is the most pressing concern among voters. With the electoral mandate, Takaichi will be able to press ahead with planned reductions in consumption taxes, expand household subsidies, and implement strategic investments and reforms in sectors such as semiconductors, shipbuilding, and AI. Additionally, increased defense spending looks likely. All in all, fiscal spending may increase by 2%–3% of GDP.

While fiscal stimulus may boost near-term growth, which has helped Japanese equities outperform global equities by 6 percentage points this year, increased government spending comes with its own risks. Notably, Japanese bond and currency markets were initially spooked in mid-January following the announcement of the snap election, reflecting concerns about debt burdens, political pressure on the Bank of Japan (BOJ), and the prospect of higher inflation.

Fiscal crisis concerns, while relevant, are overblown. Japan’s debt-to-GDP ratio has been declining in recent years, and interest expense as a percentage of GDP is lower than in other developed countries. Additionally, foreign ownership of JGBs is relatively low, reducing the likelihood of a sudden fiscal crisis or a “Liz Truss moment” similar to what the United Kingdom experienced in 2022. The recent rise in Japanese bond yields has been driven by rising inflation in Japan and reduced bond purchases by the BOJ, which has sought to shrink its balance sheet. With core inflation running close to 3%, real interest rates in Japan are still low, which is partly why the yen remains under pressure.

Tackling cost of living concerns ultimately requires a stronger yen, as a weak yen is partly to blame for inflation pressures. The Japanese government has made it clear that it will intervene if the USD/JPY exchange rate approaches the 160 level. But such a level will be hard to defend in the absence of higher interest rates. Given the election all but guarantees increased fiscal stimulus, the BOJ will need to continue hiking rates, otherwise, it risks a further rise in inflation.

Continued BOJ rate hikes, combined with modest rate cuts by the Federal Reserve, would further narrow the yield gap between Japan and the United States, providing support for the yen. Additionally, higher government bond yields in Japan could prompt the repatriation of some Japanese overseas bond holdings, exerting further upward pressure on the yen.

Overall, we see the election outcome as positive for the Japanese economy and, by extension, the yen. To capitalize on this outlook, we favor strategies that are less sensitive to JPY appreciation. Specifically, we like Japanese small-cap equities, which are a significant component of our current tactical recommendation to overweight developed markets small caps, as well as private equity buyouts and activist strategies. These strategies are well-positioned to benefit from stronger domestic growth and the ongoing momentum in corporate governance reforms and merger & acquisition activity within Japan’s market.

Footnotes

1. Identifying tax-efficient fund structures is a critical component of manager selection, as the after-tax return differential between tax-efficient and tax-inefficient hedge funds can be substantial.

The post Japanese Election Result Should Boost the Economy and Ultimately the Japanese Yen appeared first on Cambridge Associates.

by TJ Scavone

Yields on most major developed market (DM) sovereign bonds reached a multi-year high in 2023 and have since held just below those highs, trading in a relatively narrow range. We expect this pattern to persist into 2026, supported by a resilient yet uncertain economic and policy backdrop, fair valuations in most markets, and ongoing yield curve pressures. Investors should keep allocations to high-quality sovereigns closely aligned with policy guidelines.

Looking ahead to 2026, the environment for most high-quality sovereigns remains broadly supportive. Economic growth is healthy but slowing—DM real GDP is projected to rise 1.7% in 2025, down from 1.9% in 2024, with most of the deceleration in the United States. While US consumer spending remains supportive, the labor market has softened, and the full impact of tariffs remains uncertain. These dynamics are likely to keep the Fed and other major central banks biased toward modestly easing in 2026, despite persistent inflation concerns. Overall, softer labor markets, tariff headwinds, and resilient but softer growth—supported by healthy consumer spending, AI capex, and easier policy—should limit both recession and inflation risks, resulting in modestly lower policy rates in many markets and rangebound sovereign bond yields in 2026.

Given this backdrop, we recommend maintaining exposure to high-quality sovereign bonds, with duration risk kept in line with benchmarks. The case for a short-duration stance has weakened as short-term rates have declined and yield curves have steepened, raising the opportunity cost of holding cash. Likewise, the case for adopting a long-duration stance is not compelling. Long duration typically outperforms when growth slows and central banks ease, but we anticipate only limited monetary easing. The European Central Bank and Bank of England have already delivered most of their anticipated cuts and markets are pricing in around 75 basis points (bps) of Fed cuts in 2026—a scenario that looks optimistic, considering current risks. Additionally, sovereign bond yields in key markets, like the United States and euro area, are currently in the bottom half of what we consider their fair value ranges, leaving little room for further declines absent a recession.

There are risk factors that warrant close attention. We have recently seen longer-duration sovereigns underperform as a range of influences—including fiscal concerns, elevated macro volatility, and cyclical factors—have put upward pressure on yields further out the curve. Fiscal pressures in particular have repeatedly made headlines in recent years, with many DM countries facing challenging fiscal outlooks and heightened volatility around budget stand-offs. While fiscal pressures warrant monitoring, market pricing does not signal imminent fiscal crisis, nor are they the sole driver. Elevated macro volatility, structural headwinds, and cyclical factors like monetary policy have also contributed. Many of these influences should reverse in a growth shock, allowing bonds to rally and provide portfolio ballast, as seen at points this cycle. However, with these crosscurrents, investors should demand more attractive yields before adding exposure. For context, yields would need to rise another 130 bps–180 bps to reach the upper end of their implied fair value range in the United States and Germany. Some regions offer more value, but domestic and currency risks need to be considered. In most cases, we recommend waiting for more attractive US Treasury valuations—given global spillover effects—before extending duration risk.

Overall, we anticipate that bonds will outperform cash in most major markets—supported by steeper yield curves—and should maintain their defense role in a downturn. However, since current bond yields are not especially attractive relative to our fair value estimates, we recommend maintaining allocations at policy levels, and keeping duration risk closely aligned to benchmarks.

Investors should underweight public corporate credit in 2026

by TJ Scavone

At present, the public credit universe offers few compelling opportunities. While returns have been solid and fundamentals remain sound, public credit is increasingly a one-sided trade. Spreads for both investment-grade and high-yield corporates are near historic lows, and the economic backdrop is turning less supportive. We see potential for spreads to widen in 2026 and beyond, and as a result, we favor higher-quality spread products that offer better relative value and more diversified return streams.

US investment-grade corporate bonds returned 6% annualized over the trailing three years as of November 30, and US high-yield bonds returned 10%. These strong returns were driven by high starting yields and a significant narrowing in credit spreads—down 52 bps for investment-grade and 179 bps for high-yield. The tightening in spreads, a pattern that was evidenced across most regions and instruments, was justified by robust economic and earnings growth, resilient corporate fundamentals, and subdued issuance, but yields are now less compelling, and spreads are historically tight across public credit.

While spreads could drift lower in the near term, upside for public credit is limited and downside risks have increased. The environment is more fragile, with slowing growth and emerging stress in the labor market and among low-income consumers and select corporate borrowers, highlighted by recent high-profile defaults. Riskier assets look increasingly vulnerable after the sharp run-up in equity valuations, as discussed earlier in this outlook, and the potential for slower growth and elevated costs could pressure corporate earnings and margins. Although material spread widening is not our base case, the credit cycle is maturing and risks favor wider spreads, supporting an underweight stance in public corporate credit within core fixed income.

Despite expensive public credit markets, select spread products offer compelling relative value. We favor US agency mortgage-backed securities (MBS)—particularly higher-yielding current coupons—and US municipal bonds (munis). We believe current coupon MBS are higher quality and well positioned to outperform if spreads widen, providing defense without sacrificing yield. Notably, current coupons (4.9%) now yield more than corporates (4.8%). Historically, at these levels, current coupons have outperformed corporates 62% of the time over the next two years, with returns ranging from -3% to 11% per year. Their spreads, unlike corporates, remain above historical lows with room to tighten as rate volatility subsides. Although rate volatility has declined since its recent peak, it remains somewhat elevated. With quantitative tightening ending and further modest rate cuts likely once tariff-related inflation pressures ease, there is scope for both volatility and MBS spreads to compress further, supporting returns.

Munis also offer attractive relative yields for taxable investors. For high-tax-bracket US families, munis have consistently delivered stronger after-tax returns than Treasury bonds and corporates. After adjusting for taxes, the yield advantage for munis is unusually wide—currently about 185 bps versus Treasury bonds and 93 bps versus corporates, among the widest taxable-equivalent spreads since the Global Financial Crisis, excluding isolated stress periods. Many taxable investors reduced muni holdings over the past decade, favoring Treasury bonds or, in some cases, even reaching for yield in credit, as low yields limited their tax advantage and valuations were less compelling. That is no longer the case, and the current environment favors shifting back toward munis at the margin.

Against this backdrop, it is important to recognize that public credit markets overall offer limited upside and heightened downside risk as spreads remain tight and the economic outlook softens. In this environment, we recommend a defensive posture within core fixed income, emphasizing higher-quality, more resilient sectors, with attractive relative value. US current coupon agency MBS and municipal bonds stand out for their relative yield advantage and diversification benefits. For those investors for whom these investments are appropriate, focusing on them may help position portfolios for more balanced risk-adjusted returns in 2026.

Investors should lean into private asset-based finance strategies in 2026

by Wade O’Brien

In 2026, credit investors face challenges such as expensive valuations, moderating growth and falling yields. Recent bankruptcies like First Brands and Tricolor also highlight the risk of weaker underwriting in at least some segments. We believe the solution is focusing on less correlated private credit strategies such as asset-based finance (ABF), insurance-linked securities, and litigation funding. Some of these strategies can be accessed via semi-liquid vehicles, freeing up illiquidity budgets for other parts of the portfolio.

Less correlated private credit strategies are attractive relative to expensive public credit assets. Strong demand has pushed spreads on assets like US high-yield and investment-grade bonds near the bottom decile of historical data, as we discuss elsewhere in this outlook. While demand across products is likely to be underpinned by yields near historical medians, returns are vulnerable if the pace of expected Fed cuts disappoints.

ABF funds offer investors the ability to diversify portfolios away from cyclical and expensive corporate lending. These funds lend against a variety of assets including consumer loans, real estate, and equipment leases. Underlying loans are less economically sensitive and have shorter maturities, allowing lenders to reprice them more quickly as conditions change. Accelerated cash return can also help investors concerned about slower distributions in other parts of their private portfolios. Recent bankruptcies have drawn attention to the ABF market, but were idiosyncratic, given the fraud and business practices involved. Still, they highlight the importance of careful manager selection, as both cases involved red flags that were ignored by markets. Fundraising by dedicated ABF funds has picked up but remains a fraction of the volumes seen in other private credit strategies.

While direct lending funds are currently less attractive in our view than less correlated private credit strategies, they remain attractive relative to comparable public credits. Fed rate cuts and lower spreads will impact returns, but fundamentals have been stable and defaults limited. The biggest near-term challenge for direct lending funds is competition from both the syndicated loan market and retail-targeted vehicles. Semi-liquid retail funds, including private business development corporations (BDCs) and interval funds, had accrued around $350 billion in assets by year-end 2024, a 60% increase in just two years. Reduced buyout volumes have cut supply and added to pressure on spreads, but resurgent M&A activity as rates decline and tariff uncertainty clears may help. Lower middle market lending funds, which offer higher spreads and better protections for lenders, are preferred to upper middle market.

Investors can access direct lending and ABF via open-ended vehicles as well as traditional closed-end funds. Private BDCs and interval funds may charge higher fees but offer investors the ability to more frequently adjust exposures. Investors that can access lower fee institutional evergreen funds may find them an attractive substitute for liquid credit assets featuring low spreads and yields.

Other private credit strategies—such as royalties, litigation finance, and insurance-linked securities—also have appeal. They tend to have resilient income streams insulated from the economic cycle and less sensitive to corporate fundamentals. Returns for these strategies have compared favorably with other types of private credit in recent years. These markets require highly specialized expertise, making their return streams less vulnerable to rising competition or surging demand from retail-targeted offerings.

In summary, with public credit markets offering limited value and increased competition, investors should look to private credit—especially ABF and specialized strategies—for better diversification, resilience, and risk-adjusted returns in 2026.

Footnotes

1. Identifying tax-efficient fund structures is a critical component of manager selection, as the after-tax return differential between tax-efficient and tax-inefficient hedge funds can be substantial.

The post 2026 Outlook: Fixed Income Views appeared first on Cambridge Associates.

The case of the United States

To begin, we focus on the United States, the largest market globally with significant global spillovers. The US yield curve has been steepening for some time, having bottomed out midway through 2023. Since then, most of the steepening has occurred between the two-year and ten-year segments, but in 2025, the more notable steepening has taken place between the ten-year and 30-year parts of the curve (Figure 1). To put these moves in perspective, it is useful to examine how these yield curve segments have behaved historically.

Historically, both portions of the yield curve have tended to follow a somewhat consistent path during monetary policy cycles, steepening into and during rate cutting cycles before flattening as the expansion matures. In the current cycle, the yield curve’s behaviour has been broadly consistent with past episodes (Figure 2). The ten-year/two-year curve remains at untroubling levels and is not indicative of fiscal stress. From the perspective of those who harbour fiscal concerns, the 30-year/ten-year segment has arguably steepened a little more than is typical at this stage of the cutting cycle, and at a slightly speedier rate than during the COVID-19 cycle. Still, the speed of the recent steepening is more in line with the two prior cycles.

Much of the recent concern about long-dated bonds stems from the fact that, until last month, the 30-year yield had not been very responsive to increased easing priced in at the short end, especially compared to the last cutting cycle. However, the previous cycle was unique: the economic deterioration caused by the COVID-19 pandemic was atypical, with an almost complete hiatus in economic activity and significant uncertainty about normalisation. As a result, 30-year yields declined much more in sympathy with short yields during the steep portion of the rate cutting cycle, aided by quantitative easing (QE). Historically, though, it is normal for 30-year yields to react little as cuts are priced in during more typical cycles, since many economic cycles will occur over a 30-year bond’s life, reducing sensitivity to any single cycle (Figure 3).

Drivers of recent 30-year performance

To the extent that there has been some moderate excess underperformance at the 30-year point, what explains it? One hypothesis is that inflation expectations are rising in response to recent economic or political developments. Tariffs are indeed putting some upward pressure on US inflation. The probability that Federal Reserve independence could be undermined appears to be rising, potentially leading to unjustified easing and higher future inflation. A final supposition – itself related to debt load concerns – is that central banks may target higher inflation rates over time, whether implicitly or explicitly, to reduce debt burdens in real terms (Figure 4).

All these conjectures are plausible, but recent market action does not support them. Thirty-year breakeven inflation rates have traded in a band between 2.1% and 2.5% for the past three years. At a current level of 2.21%, they are firmly in line with their historical median. Instead, the recent rise in long-dated yields has been driven by a rise in real rates.

Relative supply/demand dynamics have played a significant role. On the supply side, it is politically difficult for governments to engage in meaningful fiscal consolidation. Indeed, the inability to do so has led to the fall of four governments in France in just over a year. As a result of this dynamic, expectations for more consistently elevated budget deficits and greater government bond supply have grown in recent quarters. In the United States, for instance, the International Monetary Fund (IMF) expects the fiscal deficit to remain at or above 5.5% through 2030.

On the demand side, buyers of long-dated bonds typically differ from those of shorter-dated debt, with pension funds and insurers being notable examples. Regulatory reforms in these industries have significantly influenced long-dated bond performance. Japanese insurers, for example, had been increasing their holdings of long-term Japanese government bonds (JGBs) to meet new solvency requirements. However, after meeting those targets, they have recently become net sellers, contributing to record-high 30-year JGB yields (Figure 5). In the Netherlands, the €1.5 trillion Dutch pension industry is transitioning from a defined benefit to a defined contribution system, leading to asset allocation changes and the sale of, according to Rabobank estimates, about €127 billion in long-dated sovereign debt to increase allocations to higher-returning assets. In the United Kingdom, defined benefit pension schemes’ aggregate funded status has been in surplus long enough that de-risking (increasing allocations to long-dated debt to match liabilities) has decelerated. While these developments are most impactful domestically, they have global spillover effects.

A final factor is that central banks are no longer price-insensitive buyers of government debt. Through QE, they built up large portfolios of domestic government debt to improve monetary policy transmission when policy rates were low. Once further easing was no longer required, they shifted to rolling over maturing debt. More recently, central banks have been shrinking their balance sheets. In the United States, up to $5 billion worth of Treasurys roll off the balance sheet each month. The Eurozone, Japan, and the United Kingdom, have been more aggressive: the Eurozone allows a greater proportion of debt to roll off, while the Bank of Japan and the Bank of England (BOE) have been actively selling down their portfolios.

Lower liquidity at the long end of the curve means these policy decisions have likely had a disproportionate impact on long-dated yields, especially given simultaneous demand-side changes. However, these policies are not set in stone, and policymakers can adjust both the quantity and distribution of bond sales and reinvestments in response to market conditions ² .

Focus on the United Kingdom

Rising long-dated bond yields are an international phenomenon, not one confined to the United States. Long yields are rising and yield curves are steepening in all major bond markets. However, discussions of potential fiscal crises have focused most prominently on the United Kingdom. Superficially, this is understandable: the 30-year yield in the United Kingdom recently reached levels not seen since the late 1990s, and the UK 30-year yield spread versus the United States has also been rising (Figure 6). However, this overlooks the diverging path of short rates in both markets. Normalising for this by looking at the relative shape of the yield curves shows that the UK yield curve is in the middle of its range relative to the United States for the past 3.5 years. UK two-year yields have been stable to marginally declining in recent months, rather than spiking as they did after the September 2022 budget.

This suggests the United Kingdom is not in an acute market funding crisis, further evidenced by the recent ten-year gilt syndication being ten times oversubscribed and the resilience of sterling during these moves. This is less surprising when considering that UK government debt, while elevated at around 100% of GDP, is below all G7 peers except Germany. By 2030, the UK budget deficit is forecast to be lower than all G7 nations except Canada, according to IMF projections. While there is risk of fiscal slippage, this applies to most peers. Year-to-date GDP growth in the United Kingdom has also outstripped all G7 peers.

Despite these relatively positive metrics, the United Kingdom faces issues that cast a shadow on debt sustainability, foremost among them are supply-side constraints. Strong relative growth notwithstanding, potential growth is being crimped by underinvestment (especially post-Brexit), labour market rigidities (post-Brexit and aggravated by COVID-19), and elevated housing and energy costs. Progress on these supply-side issues would have a twofold payoff: boosting growth (improving debt sustainability via both lower deficits and a higher GDP denominator) and lowering inflation, which is currently sticky due to these bottlenecks. This would allow the BOE to cut rates more aggressively, reducing gilt interest rates.

Holding two fiscal events each year draws unnecessary focus to UK fiscal issues, which are not necessarily worse than peers on many metrics. The memory of the September 2022 budget debacle also plays a role. Negative perception is aggravated by the fiscal juggling act required to meet self-imposed fiscal rules, resulting in policy uncertainty and constraining the ability to draw up a compelling growth plan. Perception of stability is important for a current account deficit country like the United Kingdom, which relies on foreign capital inflows. All told, the United Kingdom is not in a debt crisis, and the flexibility of the BOE and Debt Management Office to moderate the size and distribution of bond sales should help smooth over any demand indigestion for long-dated bonds. Nonetheless, the upcoming Autumn Budget could engender fresh rate volatility, and markets will look for a credible deficit reduction plan.

Conclusion

Rising issuance, elevated debt levels, and cyclically rising interest rate burdens have understandably brought debt sustainability to the forefront of market participants’ minds. However, any even moderately disorderly moves in yields have been restricted to the very long end of the yield curve, not further down at the ten-year point, for instance. This suggests the drivers are more idiosyncratic to the long end, rather than a generalised debt-sustainability trade. The fact that the 30-year performance has not discriminated against Germany further indicates that imminent fiscal fears are not the primary driver. Though Bund issuance will increase in coming years, German debt sustainability is not in question in the manner of other markets.

While markets are not being driven by fiscal crisis fears, secular shifts are occurring in bond markets. We have moved from a period of consistently negative term premium (the extra return demanded to hold a long-term bond rather than rolling short-term bonds) to the return of positive term premium (Figure 7). This likely reflects a combination of factors: diminished deflationary tail risks, a more volatile inflationary profile, shifts in the supply/demand balance (increased issuance versus quantitative tightening and demographic shifts), and increased political and geopolitical volatility. These trends may prove durable. It is also possible that neutral interest rates will rise should AI deliver the productivity gains its proponents suggest. These secular changes could eventually aggravate debt load concerns in developed markets, given their already unsustainable trajectory.

While investors should remain vigilant regarding debt sustainability, markets are not beginning to price in a fiscal crisis in our view. Furthermore, given how well telegraphed many of the risk factors listed above have been for some time, it would be premature, we think, to forecast that such a crisis will unfold imminently. Indeed, this month and last, bonds across the yield curve have shown they retain the propensity to rally on the back of slowing macroeconomic data. This quality remains highly valued and underpins our conviction that high-quality fixed income should continue to play a core role in portfolios. At present, with valuations broadly in a fair-value range, we recommend maintaining a neutral duration stance and waiting for yields to become more attractive relative to fundamentals before considering an extension of duration.

Mark Sintetos also contributed to this publication.

Footnotes

1. Identifying tax-efficient fund structures is a critical component of manager selection, as the after-tax return differential between tax-efficient and tax-inefficient hedge funds can be substantial.
2. Bank of England, “Asset Purchase Facility: Gilt Sales – Market Notice 18 September 2025,” Bank of England, 18 September 2025.

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