Fixed Income: A strong case for bonds

Economies across Europe and the US have showed their resilience as central banks reduced interest rates. Further reductions may follow. All this creates an interesting landscape for bonds going forward. Selectivity and care may be critical in determining where to take duration risk and how to think about carry, rather than spread compression, as a way to generate returns. Our fixed income team believes there’s a strong case to be made for the asset class. Here are more expert insight and analysis on how we’re approaching 2026.

Government bonds: Overweight in duration

Gareth Isaac, Head of Global Multi Sector

We maintain an overweight position in duration, primarily concentrated in the UK front end. While the current UK government may struggle to reassure bond markets, we expect the Bank of England to ease policy more aggressively than currently priced for similar reasons described in Invesco’s 2026 Investment Outlook: Resilience and Rebalancing. We’ve held this view for some time. The Bank had been unexpectedly reticent to cut in the face of a weak growth outlook. But recent moderation in wage growth and controllable inflation suggests a shift toward a more accommodative stance is imminent.

Short-term interest rates may fall more quickly than long-term rates. So, we retain a curve steepening bias, preferring exposure at the very short end of the curve (two-year maturities). Our base case anticipates that the Federal Reserve (Fed) will lower rates sharply in response to softer economic conditions but could subsequently reverse course should the US economy rebound quickly. We remain underweight at the long end of yield curves across most developed markets. Structural demand for long-duration bonds has declined in recent years. With inflation remaining elevated and the Fed appearing to prioritise employment over price stability, we expect long-end yields to remain under upward pressure.

We remain constructive on local rates in select emerging markets, supported by expectations of a weaker USD and growing investor appetite for diversification amid rising developed market bond supply. Many emerging market (EM) central banks retain policy flexibility, with room to ease rates as inflation moderates, enhancing the attractiveness of local bonds.

Emerging market local debt: Strong reasons to invest

Wim Vandenhoeck, Co-Head of Emerging Markets Debt

We’re positive on emerging market local currency sovereign bonds. Inflation overall has been well managed by orthodox monetary policy, highlighting the improvement in institutional credibility, and inflation continues to moderate. As a result, most emerging market central banks have room to ease interest rates from elevated levels, enhancing the attractiveness of local bonds. Fiscal policy remains prudent, leading investors to consider the diversification benefits of emerging markets amid rising developed market fiscal concerns and resultant heavy bond issuance. Meanwhile, growth in emerging countries is projected to outpace growth in developed countries. Given all of these factors, the fundamental thesis for investment is strong.

In terms of valuations, all-in yields remain attractive despite recent strong performance, with the potential of further capital upside as central banks ease policy. This, combined with the expectation of a weaker US dollar, has seen flows into the asset class create a positive technical bid. Flows should continue as global investor exposure to emerging market assets remains modest, especially in local bonds.

More views on emerging markets can be found in Invesco’s 2026 Investment Outlook.

UK, Europe, Global Investment Grade credit: Tight spreads and minimal credit risk

Michael Matthews, Co-Head of Business Strategies, IFI Europe

Credit markets have performed well again in 2025. Spreads recovered quickly from the ‘Liberation Day’ weakness and have squeezed consistently tighter since the spring.

Credit markets are supported by the stable macroeconomic backdrop and improved financial conditions following interest rate cuts from the European Central Bank (ECB), the Bank of England, and now the US Federal Reserve.

Investor sentiment is bullish, as seen in the strength of equity markets. Demand for credit remains strong, and supply has been easily absorbed.

The challenge for credit market investors is that spreads are now close to, or at, their all-time tights. As a result, returns will likely be carry-based for the foreseeable future. There’s little variation in credit spread between sectors. In Europe, for example, the difference between the tightest and widest sectors is close to a record low.

Tight spreads mean now isn’t the time to take too much credit risk. Our general approach has been to trim exposure to weaker-rated credits and tilt the portfolios to higher-rated and more liquid issuers where the give-up in spread is relatively modest.

We’re typically taking a little more duration risk than benchmarks given the shape of yield curves and the more appealing pickup in returns on offer.

By sector, several strategies overweight the banking sector, including a small allocation to subordinated bank debt capital.

In our global strategy, we prefer Continental Europe and the UK over the US due to greater dispersion across 27 economies and more opportunities for active investors to generate alpha. Europe’s centralised and robust regulatory oversight provides creditors with greater transparency and predictability. In contrast, the US market is more homogenous and increasingly deregulated — a combination that may support corporate profitability but reduces creditor protections and limits relative value opportunities.

High Yield credit: Stable lending standards and improving credit quality

Thomas Moore, Co-head of IFI Europe

High yield corporates, and subordinated regulatory bank debt in particular, have performed well in 2025. Spreads have tightened, adding capital gain to the carry. Supported by strong investor demand, supply of high yield has risen for the fourth consecutive year. In Europe, for example, gross supply is on track for its second-strongest calendar year in more than a decade with more than 200 new bonds issued. Despite this strong backdrop, the proportion of issues rated CCC is very low, indicating stable lending standards. Credit quality, as judged by the declining default rate, is set to improve further.

However, the market isn’t without its risks. Whilst the core and stronger parts of the market have performed well, weaker credits have struggled for a mix of company-specific and sector-based reasons. A good example is chemicals, a sector in which many issuers are struggling under the weight of surging supply from China and weak demand from key industry customers such as autos and housing.

We’re still very much active in the primary market but as usual are assessing issuers on a case-by-case basis. We expect more modest returns given the prevailing yield backdrop.

ETF investment teams: Net inflows setting records

Paul Syms, EMEA ETF Head of FI & Commodity

Net inflows into fixed income UCITS ETFs proceeded at record pace in 2025. The $62 billion raised through October falls just $6 billion shy of 2023’s total for the year. (And strong flows have been seen in equity ETFs and commodity ETFs as well, a clear indication of broad ETF adoption from both retail investors and institutional asset managers.) 

Assets under management for European-domiciled fixed income ETFs recently broke $600 billion. Fees on traditional exposures have become increasingly competitive with a wider choice of ETFs available. Yields remain at attractive levels relative to their post-GFC average which, along with geopolitical uncertainty, have spurred demand for cash management and government bond ETFs.

With major central banks having eased policy, investors have looked to maximise returns on their cash. That’s led to new launches in swap-based ETFs whose structure can help create outperformance versus overnight rates. Meanwhile, regulatory changes have led to the launch of AAA CLO ETFs which offer attractive levels of income but remain very high quality while having low interest rate (i.e., duration) risk.

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