Active fixed income strategies delivered their best results in years in 2025 – and the outlook ahead is just as compelling amid one of the most exciting environments for alpha generation in recent memory.
Investors have a rare opportunity to increase quality and liquidity without giving up equity-like return potential – at a time when stock market valuations have reached extremes.
Economic outlook: Dimensions of divergence
Global growth remains surprisingly resilient. After withstanding tariff pressures in 2025, the near-term outlook appears stronger, aided by AI-related capital spending and efficiency gains.
However, "K-shaped" economic trends are apparent across households, companies, and regions. Indeed, those who are better positioned to benefit from the AI race and associated wealth effects are fuelling growth. Others are increasingly at risk of being left behind.
Meanwhile, global monetary and fiscal policies are moving in different directions. The U.K. and several emerging market (EM) economies with high real rates and limited fiscal space are likely to ease monetary policy more than the European Central Bank or Bank of Canada, where policy is already neutral. We also expect U.S. Federal Reserve (the Fed) rate cuts in 2026, likely in the latter half of the year.
Fiscal policy is set to become more influential in China amid trade pressures, and in the U.S. where tax cuts will likely boost households and businesses.
Investment implications: take advantage of the fixed income opportunity
After years of strong risk-asset returns, equity valuations remain elevated and credit spreads are tight.
History suggests that these starting valuations will influence forward returns, which may be lower than investors have come to expect.
By contrast, bonds are cheap versus stocks at current valuations. After a sharp post-pandemic repricing, starting yields on high quality bonds remain attractive, highlighting the sustainable return potential in fixed income.
Even after broadly strong bond market returns in 2025, the yield on the benchmark 10-year U.S. Treasury note – about 4.19% as of 12 January 2026 – remains in the middle of the 3.5%–5% range that it has occupied for more than three years. Other DM sovereign 10-year yields tell a similar story. This illustrates that robust bond returns don't depend on a broad rally in rates.
Rather, attractive starting yields provide a baseline from which active managers can seek to construct portfolios potentially yielding about 5%–7% by capitalizing on alpha opportunities.
Amid a generally benign global growth outlook, and with attractive yields available in many countries, we favour a diversified portfolio of exposures across regions with different economic and policy paths, including Developed Market (DM) and select EM local markets.
Rates, duration, and global opportunities
As yield curves have steepened, we believe investors who continue holding excess cash are missing a potential opportunity. By turning to fixed income, which has outperformed cash, investors can lock in more attractive yields over a longer period while also benefiting from potential price appreciation for a modest increase in risk.
We maintain a modest overweight to duration – a gauge of interest rate exposure – with a focus on global diversification..
U.S. duration still looks attractive and can help hedge portfolios against a potential slowdown in the U.S. labour market or AI-related equity volatility. European duration looks comparatively less attractive.
We continue to like Treasury Inflation-Protected Securities (TIPS), commodities, and real asset exposures. Meanwhile, we see select opportunities in countries with higher real policy rates, tighter fiscal settings, and more balanced inflation risks. This includes the U.K. and select EM countries.
Emerging markets: asymmetric opportunities in a fragmented world
For active managers, dispersion creates opportunity. Unlike the 2010s when EM moved as a bloc, today's environment rewards granular country selection across rates, currencies, and credit. Across EM, we find attractive starting yields and a variety of idiosyncratic, diversifiable risks.
EM central banks are expected to continue to cut rates amid low inflation and resilient foreign exchange. We prefer duration overweights in South Africa and Peru, where yield curves are steeper than domestic fundamentals warrant, and Brazil, where we see room for a large and extended rate-cutting cycle.
We continue to see the potential for U.S. dollar weakness, reflecting the ongoing Fed easing cycle, secular fiscal concerns, and starting valuations that favour an overweight to EM currencies versus DM counterparts.
See our June 2025 Secular Outlook, "The Fragmentation Era"
Credit: constructive but selective
We are seeing signs of later-cycle behaviour in credit markets as strong recent returns have fuelled complacency.
We expect continued deterioration in credit fundamentals, especially in floating-rate sectors of corporate markets. Industry and single name exposure will matter, as we see fundamental pressure in areas such as healthcare, retail, and technology.
We have seen an increase in amendment activity, such as payment in kind (PIK) provisions that allow borrowers to repay debt with more debt. Such trends can mask underlying stress by keeping headline default rates low.
We have also observed overreliance on rating agency ratings as a barometer for risk, and vehicles promising more liquidity than their underlying investment strategies may be able to deliver.
During such periods, we look to reduce generic credit exposure – or beta – and focus on independent, bottom-up analysis and security selection.
We continue to favour U.S. agency mortgage-backed securities (MBS), which are supported by strong structural features, robust liquidity, and attractive spreads.
Rather than regarding credit markets as separate public and private segments, we continue to evaluate investments along continuums of economic sensitivity and liquidity risk, and we focus on ensuring adequate compensation for these risks.
Investment grade issuers with stable cash flow and strong balance sheets remain the core of our credit positioning. We value the robust liquidity in public investment grade markets and believe investors should be selective when venturing into private investment grade, especially when incremental spread over more liquid opportunities is limited.
We expect secured lending in areas such as asset-based finance, real estate credit, and well-structured infrastructure debt to outperform. Lower-quality segments of corporate markets are more likely to disappoint given tight spreads, weak underwriting, and broader signs of overall complacency.
This material is provided for informational purposes only and does not constitute an offer to sell or a solicitation to buy interests in any PIMCO fund or investment product.
Any views expressed are those of PIMCO which may not have been updated to reflect real-time market developments. Statements of opinion are subject to change, without notice, and are based on current market and other conditions. No representation is made or assurance given that such views are correct.
Certain information contained herein concerning economic trends and/or data is based on or derived from information provided by independent third-party sources. PIMCO believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. References to Agency and non-agency mortgage-backed securities refer to mortgages issued in the United States. Private credit involves an investment in non-publicly traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Equities may decline in value due to both real and perceived general market, economic and industry conditions.
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