Fixed Income Forward – December 2025

With no US Federal Reserve (Fed) policy meeting, and economic data releases delayed by the US government shutdown, global bond markets had mostly sentiment to go by in November. As for expectations around a US rate cut in December, futures markets have changed their bets several times over the past few weeks. According to data from the CME FedWatch Tool, the odds of a December rate cut were above 90% in mid-October, then dropped below 50% in early November, only to climb back up to around 80% at month end. A December cut would bring the target range to 3.50%-3.75%.

We expect policy rates in advanced economies to continue to move towards neutral levels, but at varying speeds. Business activity indicators point to economic resilience in major advanced economies, with the US and Japan showing signs of acceleration while the euro area holds steady. The UK remains challenged by a weakening labour market and slower growth. With its Autumn Budget, the UK government sought to reassure markets that it can improve public finances. Gilt investors seem content for now. As inflation softens, the Bank of England may have room to cut rates in December.

With the resumption of policy easing on the horizon – Japan excepted – we favour front-end US rates while preferring to take longer-dated exposure in emerging market sovereign debt, eg, Brazil, Peru, South Africa, Malaysia. We think the macro and policy backdrop still points to US yield-curve steepening. Should a more politicised and “growth-friendly” Fed emerge, short-dated bonds would likely benefit; meanwhile, a muddy inflation and fiscal outlook is set to hurt long-dated bonds. In contrast, the inflation and fiscal picture in many emerging markets is rosier, with already steeper yield curves and more runway to cut rates if growth disappoints.

Without a credit or growth shock as our base case scenario for 2026, resilient income remains a central theme. Credit spreads look set to close the year tighter despite bouts of widening and high levels of new issuance. A rush to lock in historically high all-in yields seems to have supported demand for spread assets. Importantly, solid corporate earnings, improved creditworthiness and macroeconomic outperformance in emerging markets contribute to this favourable backdrop.

For investors with large cash balances, falling short-term interest rates pose reinvestment risk. Extending maturities in core government bond markets can be a volatile bet. This year, long-dated bond yields in some core markets have risen more than same-maturity interest-rate swap rates. We think term premiums could rise further as countries such as Germany issue more sovereign bonds and fiscal fears prompt liquidity crunches at the back end of yield curves. In this context, we expect asset allocators to maintain and even increase spread product exposure, with greater diversification across geographies, sectors and ratings. At the same time, we think it’s important to stay active in managing duration in portfolios as duration (especially US Treasuries) remains a reliable hedge to growth risks.

In investment grade credit, we still like floating-rate notes as a “first line of defence” to falling money-market rates since these instruments trade at a yield spread above benchmark short-term rates. In high-grade fixed-rate bonds, we maintain a moderately overweight credit allocation given that fundamentals and technicals support this asset class. Our allocation leans into higher quality tiers, with a bias towards financials and utilities versus cyclical industrials. While retaining our high conviction to financials, we have reduced our relative exposure to the sector, based primarily on valuations, and have rotated into more senior parts of the capital structure. 

In high yield, we are being very selective – even though we see a low default outlook (away from certain sectors and lower-rated issuers). In the BB-rated segment, there is little spread differential between the US and Europe, while European single Bs are trading wider and may offer select opportunities. In Asia, we maintain a preference for high yield over investment grade for the carry, while in high yield we generally favour BBs over Bs, consistent with our more defensive stance.

1. Fed meeting - After a pause in November, the US central bank meets again on 9-10 December to decide on rates. The October meeting revealed divisions among voting members, with some worried about a softening jobs market and others wary of inflation. October-November jobs data, as well as key inflation figures, won’t be released until after the Fed meets.
2. Ukraine conflict - Energy prices, as well as eastern European currencies, have been volatile amid renewed talks to reach a Russia-Ukraine peace deal. The latest diplomatic push involves a US plan that both Ukraine and EU leaders have criticised as too favourable to Russia. A lasting deal at this juncture is unlikely; commodity and currency markets remain highly sensitive to the newsflow.
3. AI bonds - Unlike in the dot-com era, today’s AI infrastructure spend is largely financed by strong cash flows and public sector-backed initiatives rather than corporate leverage. That said, so-called AI hyperscalers have overtaken banks this year as the largest (in volume) high-grade bond issuers in the US. AI capex is bound to face greater investor scrutiny amid record tech valuations and bond issuance.

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