Navigating Rates
Fixed Income Forward: February 2026
We foresee a narrower range of macro outcomes in 2026. Our base case of a reflation-type macro scenario with overall accommodative financial conditions supports a carry environment. We also note that the renminbi has begun to appreciate at an accelerating pace in recent weeks.
Key takeaways
- Carry and roll-down generally work well in range-bound markets.
- Rising asymmetric risk amid tight spreads calls for careful security selection.
- Anchoring in fundamentals and structural convictions, with active style and disciplined risk management, may give the best chance of capturing opportunities as volatility arises.
“The greatest danger in times of turbulence is not the turbulence. It is to act with yesterday’s logic.”
Peter Ferdinand Drucker
What happened in January
Investors entered 2026 with their hands (lots of new issues) and heads (lots of headlines) full.
Unsurprising central bank actions – from the US Federal Reserve (Fed), the Bank of Japan and the Bank of Canada – have kept investors’ attention on messaging, forecasts and corporate earnings, as well as geopolitical developments.
Davos, with its ‘spirit of dialogue’ theme, has redirected global investor attention to policy and geopolitical risks.
US President Donald Trump’s comments on Greenland, as well as uncertainty around the Fed chair nomination triggered panic selling of the US dollar, despite overall strong economic data from the US.
Across the Pacific Ocean, Japan triggered a short-lived global rates wobble with the 40-year bond yield hitting a record high of 4% after after Prime Minister Sanae Takaichi called a snap election for 8 February with a view to gaining a stronger mandate for expansionary fiscal stimulus.
The renminbi has begun to appreciate at an accelerating pace in recent weeks, with the People's Bank of China setting the daily fixing at successively stronger rates. This underlines an important policy shift, with far-reaching implications.
Our take: investment implications
Overall, we foresee a narrower range of macro outcomes in 2026. Our base case of a reflation-type macro scenario with overall accommodative financial conditions supports a carry environment.
In global rates, monetary policy settings in the major economies are around or approaching neutral levels. In a range-bound market with a reflationary tilt, we don’t want to be outright long headline duration. We think the risk of Japan repatriation flows remains underpriced, so does the general deterioration of fiscal balances across OECD countries. We favour expressing such views via yield curve steepeners.
In currencies, we think the US dollar’s slump in January is not explained by economic weakness. All else equal, economic data and surging energy price should otherwise be positive for US dollar, especially compared with euro zone and Japan. Rather, the move was triggered by a re-rating of risk premia based on several noneconomic factors, among them worries over the Fed’s independence and institutional credibility, and US foreign policy. The US dollar staged a relief rally after Mr Trump nominated Kevin Warsh to be the next Fed chair. Nonetheless, our expectation of a structurally weaker US dollar remains intact – we believe the greenback remains overvalued and that it is reasonable to expect it to revert to the mean over time. We like to express this view via long selective Asian FX and high-carry emerging market FX.
For global credits, the environment remains positive for taking credit carry as headline yields remain attractive and fundamentals remain solid enough. The sweet spot of a blended portfolio of BBB and BB-rated bonds may offer decent income without too much fragility. However, asymmetric risk arises along with tightening spreads. This requires careful security selection, particularly in economies and sectors where cycles start to turn.
While we don’t want to be outright long duration, high-quality duration remains one of the most effective hedges that a multi-sector fixed income portfolio can adopt against a risk-off move. Today, we are being paid relatively better to own that hedge through carry and roll-down.
We continue to see emerging market debt as one of the best diversifiers in a global fixed income portfolio, particularly in a carry environment with a structurally weaker US dollar. While valuations are not cheap, there are good reasons to believe the strong performance seen in 2025 and so far in 2026 could continue. Given the heterogeneous nature of emerging markets, and the fact that the easiest gains were already made in 2025, it stands to reason that the next phase of the rally will require investors to be more selective.
Chart of the month: Performance of the renminbi and yen against the US dollar
CNY = renminbi
JPY = Japanese yen
Source: Allianz Global Investors, Bloomberg, as at 31 January 2026. The information is provided for illustrative purposes only, it should not be considered a recommendation to purchase or sell any particular security or strategy or as investment advice. Past performance, or any prediction, projection or forecast, is not indicative of future performance.
January’s sharp sell-off of the US dollar was not about relative economic weakness or monetary policy. Recent US growth data has surprised on the upside – all else equal, this is positive for the dollar, especially as European and Japanese data have delivered fewer positive surprises lately. Moreover, the recent rise in natural gas prices should support the currency of the US, a major gas exporter, while weighing on the currencies of the euro zone and Japan, which import gas. In fact, the sell-off was triggered by a re-rating of risk premia based on lost confidence in US institutional creditability, Federal Reserve independence and worries on US foreign policies. Therefore, it is not surprising that the dollar staged a relief rally after Kevin Warsh was nominated as the next Fed chair. What’s more interesting is the move in the renminbi over the past 50 trading sessions, which underlines an important policy shift from the People's Bank of China in favour of allowing the Chinese currency to appreciate. By the standards of other currencies, the moves so far are small. But the implications are far-reaching – potentially epochal. If the Japanese yen were to join the trend, the impact on global financial markets would be profound.
What to Watch
- Corporate earnings - The earnings season so far has been robust, with growth at S&P 500 companies tracking at nearly 12%, which is above estimates. If the current rate of earnings growth holds, it would mark the fifth consecutive quarter of double-digit expansion. Analysts are watching for any margin pressures owing to capital expenditure on AI.
- Oil prices - Rising geopolitical risk over Iran could lift Brent oil prices back over USD 70 a barrel. In February, the US reportedly shot down an Iranian drone aimed at the aircraft carrier USS Abraham Lincoln. Despite this, negotiations between the US and Iran are expected to continue. A sustained crude oil spike could impact headline inflation, trade balances and consumer sentiment.
- Renminbi and yen - The undervaluation of the Chinese renminbi and Japanese yen is one of the biggest anomalies in global financial markets. In recent weeks, both currencies, particularly the renminbi, have begun to move in a different direction, albeit triggered by different reasons. If they continue to appreciate (which in our view they will, particularly the renminbi), the implications for the global financial system will be far-reaching.
Fixed income market performance
Source: Bloomberg, ICE BofA and JP Morgan indices; Allianz Global Investors, data as at 30 January 2025. Index returns in USD-hedged except for Euro indices (in EUR). Asian and emerging-market indices represent USD denominated bonds. Yield-to-worst adjusts down the yield-to-maturity for corporate bonds which can be “called away” (redeemed optionally at predetermined times before their maturity date). Effective duration also takes into account the effect of these “call options”. The information above is provided for illustrative purposes only, it should not be considered a recommendation to purchase or sell any particular security or strategy or as investment advice. Past performance, or any prediction, projection or forecast, is not indicative of future performance.
* Represents the lowest potential yield that an investor could theoretically receive on the bond up to maturity if bought at the current price (excluding the default case of the issuer). The yield to worst is determined by making worst-case scenario assumptions, calculating the returns that would be received if worst-case scenario provisions, including prepayment, call or sinking fund, are used by the issuer (excluding the default case). It is assumed that the bonds are held until maturity and interest income is reinvested on the same conditions. The yield to worst is a portfolio characteristic; in particular, it does not reflect the actual fund income. The expenses charged to the fund are not taken into account. As a result, the yield to worst does not predict future returns of a bond fund.
