View on rates: Uneven policies, selective duration

The global economy has entered 2026 in a late-cycle configuration: resilient growth, persistent pockets of inflation, elevated asset valuations, and historically high public deficits. The synchronised monetary easing of the past two years is now giving way to a phase of clear policy divergence. The Federal Reserve (Fed) is on hold, with markets pricing around 50 basis points of easing; the European Central Bank (ECB) and the Bank of England are also on hold, albeit with different biases; the Bank of Japan (BoJ) is cautiously normalising; and the Reserve Bank of Australia delivered a hawkish hike at its February meeting.

At the same time, fiscal policy has re-emerged as the dominant macro force. In the US, the deficit is expected to remain close to 6% of GDP in 2026¹, while Germany’s fiscal expansion is reshaping euro area growth and supply dynamics.

This shift from monetary to fiscal leadership is altering the nature of risk premia embedded in sovereign yield curves. With structurally higher issuance, inflation not fully extinguished and growing political uncertainty, supply dynamics and term premia are becoming as important as central bank reaction functions. Sovereign bonds can no longer be assessed solely through the prism of policy rates; duration risk increasingly reflects fiscal sustainability, debt absorption capacity, and institutional stability.

Against this backdrop, we favour differentiated duration exposure: short US and Japan, long Germany, cautious on non-core Europe and constructive on selected emerging markets.

US yields declined in 2025 as recession fears resurfaced and the Fed pivoted toward easing. Yet that rally increasingly appears at odds with underlying fundamentals.

The US economy continues to demonstrate resilience. Leading indicators remain consistent with growth running around 2–2.5% in 2026, supported by AI-driven capital expenditure and the fiscal impulse embedded in the “One Big Beautiful Bill.” The labour market has cooled but not cracked, with unemployment stabilising in the mid-4% range, far from recession territory.

Fiscal gravity, however, cannot be ignored. Recent projections suggest that the 12-month federal deficit-to-GDP ratio could rise from roughly 5.3% at the start of 2026 to around 6.0% by year-end¹—well above pre-pandemic norms and roughly double the 2015–2019 average. While this does not signal an imminent fiscal crisis, it confirms that deficits are set to remain structurally large. In nominal terms, this implies continued heavy Treasury issuance. Even if net supply moderates at the front end, long-dated duration remains structurally abundant, particularly at a time when traditional price-insensitive buyers are less dominant.

Inflation remains sticky in core components and above the Fed’s target. Core PCE is projected to hover well above 2% in 2026, with risks skewed to the upside. Against this backdrop, markets are pricing roughly 50 basis points of rate cuts in 2026—an assumption that may prove optimistic if growth holds near trend and fiscal policy remains supportive.

Europe is gradually emerging from stagnation into a more visible cyclical recovery. Germany, long the region’s weak link, has marked a meaningful shift by easing its debt brake and committing up to €500 billion to infrastructure and defence, a move that could add between 0.5% and 1% to annual GDP over the next decade. After a tepid 2025, forward-looking indicators (factory orders, industrial production and credit) are improving, suggesting momentum is building.

This momentum extends beyond Germany. Italy continues to benefit from EU recovery funds, France maintains elevated public spending, and Spain is supported by solid domestic demand and EU financing. Together, this coordinated fiscal stance is sufficient to generate a cyclical upswing, even as private investment and export competitiveness remain structural weaknesses.

We therefore expect euro area growth of around 1.3% in 2026, slightly above consensus. While the upswing is real, modest productivity gains, slow reforms and persistent political fragmentation mean its durability will depend on transforming a fiscally supported rebound into sustainable, private-sector-driven growth.

Inflation, meanwhile, is evolving along a more reassuring path. Price pressures are easing more convincingly than in the US, supported by fading energy effects and a gradual moderation in wage dynamics. This environment places the ECB, in its own words, “in a good place”². Disinflation is progressing, albeit at a slower pace; labour markets remain resilient; and fiscal expansion reduces the urgency to ease further, while the asymmetry of risks makes additional tightening unlikely.

While Germany stands as the fiscal pillar of the eurozone recovery, the picture is more nuanced elsewhere. The factors underpinning German stability: credible institutions, strong fiscal capacity and safe-haven status, are not uniformly shared across the periphery. Spreads remain historically tight, reflecting a market driven by carry and the search for yield. Yet this environment risks masking underlying fiscal and political vulnerabilities in certain countries, with France standing out as a notable example.

Meanwhile, the modest fiscal consolidation planned for 2026, based mainly on selective tax increases and restrained spending, should act as a drag on investment and growth. Persistent uncertainty around the fiscal path risks further dampening private-sector confidence and capital expenditure, widening the gap with more dynamic parts of the euro area. With deficits expected to remain above 5% of GDP and debt exceeding 110%, France remains exposed to renewed rating pressure.

We do not see systemic risk, but we do see fragility. At around 60 basis points versus Bunds—a low since the June 2024 dissolution—spreads offer limited cushion against adverse surprises and could revisit the 70–90 basis points range in negative scenarios.

For more than three decades, Japan defied gravity. Growth was subdued, inflation absent, and government bond yields hovered near zero, even as public debt climbed to levels unmatched in the developed world. That equilibrium, sustained by financial repression, central bank dominance and vast external asset accumulation, is now shifting. Inflation has re-emerged, wage negotiations are delivering the strongest increases in a generation, and nominal GDP is regaining momentum. What once appeared cyclical, increasingly looks structural: corporate pricing behaviour is evolving, labour shortages are binding in a rapidly ageing society, and inflation expectations are adjusting. In a country where almost 30% of the population is over 65⁴, we believe labour scarcity is structural rather than temporary.

The decisive election of Sanae Takaichi reinforces this inflection point. With a strong mandate, the new administration is advancing industrial policy, energy security and defence initiatives, alongside a rapid €117 billion stimulus package⁵ and targeted tax relief aimed at cushioning households from persistent food inflation. Fiscal activism is no longer merely counter-cyclical support; it has become strategic. While Japan retains fiscal capacity—supported by its position as the world’s largest net external creditor — the macro-financial regime is changing.

While policymakers remain mindful of financial stability — aware that abrupt moves could unsettle global carry trades — they cannot allow inflation expectations to drift. Further measured tightening therefore remains the most credible course.

The adjustment is unlikely to be uniform across the curve. Upward pressure should remain concentrated in intermediate maturities, while the long end may stabilise after its recent repricing. Thirty-year yields have returned to positive real territory, a level that could attract more durable demand. In an economy rediscovering nominal growth, permanently repressed yields are no longer the only plausible anchor.

Another of our core convictions is that the global economy is shifting towards a regime of structurally higher inflation. The powerful disinflationary forces of the past three decades — globalisation, abundant labour, cheap energy, and fiscal restraint — are giving way to a costlier model built on ecological transition, nearshoring, national security, and persistent fiscal activism.

Nowhere is this transition more visible than in the US. The economy continues to operate close to or above potential, supported by AI-driven capital expenditure and sustained fiscal expansion. Beyond its productivity promise, the AI investment cycle is capital- and resource-intensive: data centre build-outs, rising energy demand and strategic commodity inputs are already generating pockets of price pressure. Nominal growth remains firm and the output gap positive, conditions under which inflation rarely returns smoothly to target.

Recent data confirm this stickiness. Core inflation has reaccelerated, particularly in services, where wage-intensive and inertial components remain inconsistent with a durable 2% regime⁶. Measures of underlying momentum — including supercore readings and the breadth of components running above target — suggest that price pressures remain more diffused than headline trends imply. Shelter disinflation is proving slower and more uneven than expected, while tariff-related pressures continue to feed through as inventories are rebuilt at higher import costs.

Policy dynamics add further complexity. While the Fed has adopted a more dovish stance and markets price additional easing, fiscal policy remains expansionary and growth resilient. At the same time, restrictive immigration policies are constraining labour supply just as demand strengthens, raising the risk of renewed wage pressures. Markets continue to anchor long-term inflation expectations of near 2%, a positioning that appears complacent relative to underlying macro dynamics.

We are not predicting a renewed inflation shock. Rather, inflation is likely to settle on a higher-for-longer plateau in an environment where growth remains resilient and supply constraints linger. We therefore express this conviction through exposure to US breakeven inflation strategies, which we view both as an efficient way to capture the asymmetry in inflation risks and as a portfolio hedge against a macro regime in which price pressures prove more persistent than currently discounted.

Emerging market local debt entered 2026 with a rare alignment of supportive forces. US exceptionalism is fading, global growth is moderating, and inflation across many emerging economies continues to ease, creating room for more accommodative monetary policy. Real yields remain attractive, debt dynamics are generally more favourable than in developed markets, and volatility has structurally declined.

In an environment shaped by a weaker USD and expected Fed easing, local rate markets are well positioned to deliver both carry and duration gains.

That constructive backdrop, however, does not apply uniformly across the universe. Selectivity is essential. We are focusing on countries where restrictive policy settings, improving fundamentals and credible central banks create clear room for rates to decline.

In Latin America, Brazil and Mexico offer compelling opportunities. Brazil’s Selic rate remains elevated in the mid-teens⁸, providing substantial carry, while inflation is moderating and growth is slowing, paving the way for eventual easing. Mexico also combines high real rates with a central bank already in a cutting cycle.

Across these markets, we see an attractive balance between income generation and potential capital appreciation — a combination increasingly scarce in developed fixed income markets.

Summary of views and positioning within Carmignac's Fixed Income range⁹: