Carry instead of rate cut to drive bond returns in 2026

Binaya Dahal

Journalist

23 January 2026

While lower interest rates in the US and Europe provide a broadly supportive backdrop for fixed income, the dominant driver of returns this year will be carry – the income earned from holding bonds, according to BNP Paribas Group’s CIO Chris Iggo.

“Significant drawdowns in fixed income markets tend to only occur in response to a growth or credit shock,” Iggo said, adding he sees neither happening after the robust performance in 2025.

“In the absence of a growth or credit shock, carry will be a major theme for bond investors, delivering most of the total return.”

As inflation pressures recede and growth risks rise, Iggo sees more price reliefs on the way but warned that lower rates will not automatically translate into strong capital gains for government bonds.

He adds long-term yields have already risen relative to swap rates over the past year and debt levels in advanced economies remain on an unfavourable long-term trajectory.

“The benign outlook for nominal growth and policy efforts to appease bond markets should limit any cases of fiscal panic,” he said.

“Despite this benign rate outlook, sovereign markets will remain at risk of increased investor concern on the fiscal side.”

That backdrop, according to Iggo, pushed investors to reassess the relative appeal of credit markets, proved by it being buoyant throughout 2025 despite elevated levels of issuance.

Iggo said the key question moving forward will be whether investors continue to value diversified corporate risk more than increasingly leveraged sovereign balance sheets.

“In which case, prevailing yields in credit markets are attractive and should deliver attractive income-driven total returns,” Iggo said.

However, he cautioned that credit markets will experience periods of underperformance relative to government bonds in case of weaker economic data, equity market volatility or evidence of growing credit stresses in either private or public markets.

“Geographically, US markets are most at risk from any deviation from the benign core scenario. Tariffs and the impact of immigration controls on labour supply could combine to keep inflation higher for longer,” Iggo said.

“This not only complicates the Federal Reserve’s decision-making but also reduces expected real returns from US fixed income.”