- After strong 2025 returns for both stocks and bonds, strategists expect 2026 bond gains to be hard to repeat even if the Fed cuts rates.
- Sticky ~3% inflation, solid growth, and large deficits are seen pushing long-term yields higher rather than lower.
- Forecasts put the 10-year Treasury near ~4.3–4.6% and warn long bonds could suffer large price losses if term premiums rise.
- Investors are urged to avoid long duration and favor shorter maturities, floating-rate, or inflation-linked exposure amid higher volatility and Fed-independence risks.
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The strong performance of both stock and bond markets in 2025 is unlikely to be replicated in 2026. Although consensus expects the Federal Reserve to cut short-term rates twice this year, the combination of persistent inflation (around 3%), stronger economic growth, and large federal deficits point toward higher longer-term yields rather than the declines needed to sustain bond returns.
Key forecasts indicate the 10-year Treasury note could reach 4.6%, up from the recent 4.0-4.2% range, reflecting inflation, growth, and fiscal deficits. A modest rise in yield to ~4.3% would already make total returns unattractive compared to rolling short-term Treasurys. Long maturities, especially 30-year bonds, are exposed: if the yield spread between 30-year bonds and the fed funds rate expands—as seen in past cycles—prices could fall up to ~30%.
The U.S. federal budget deficit remains elevated. FY 2025 saw a deficit of approximately $1.775-1.8 trillion, roughly 5.8-6.0% of GDP. Revenue gains from tariffs and cuts in certain outlays helped, but interest and entitlement spending continue to rise, increasing debt service burdens and pushing up long-run rates.
Adding to market risk, political pressure—especially from the Trump administration—toward lowering yields and influencing Fed policy increases uncertainty. Moves like ordering Fannie Mae and Freddie Mac to purchase $200 billion in mortgage-backed securities reflect this pressure, which could complicate the Fed’s ability to remain credible, especially amid upcoming leadership changes.
Strategically, investors should guard against downside in long-duration fixed income, shifting toward shorter durations, floating-rate assets, or instruments better linked to inflation. Equities might benefit from above-trend growth if inflation moderates, but rising yields pose risks for growth stocks and sectors sensitive to borrowing costs. Close attention should be paid to fiscal developments, central bank governance, and inflation trends as potential catalysts for sharp adjustments.
Open questions include: how aggressive the Federal Reserve will be despite political influence; how inflation readings will behave given cost pressures and wage dynamics; whether budget deficits will be controlled or increase further; and how bond markets will react to any perceived threat to Fed independence.
Supporting Notes
- The 10-year Treasury yield ranged between 4.0% and 4.2% in recent months, which analysts say fails to offer inflation protection given ~3% inflation.
- Fed rate cuts: futures markets expect two 25-basis-point cuts in 2026, likely in June and September, but these cuts may arrive too late to prevent yield increases.
- Deficit data: FY 2025 deficit at roughly $1.775-1.80 trillion, equivalent to about 5.8-6.0% of GDP.
- Interest costs hit record highs in FY 2025: interest on the debt reached ~$1.2 trillion; spending on entitlements and defense also steadily increased.
- Policy interventions: President Trump ordered Fannie Mae & Freddie Mac to buy $200 billion in mortgage-backed securities to try to push down rates.
- Yield risk: Evercore ISI’s Stan Shipley sees year-end 10-year yields around 4.3%; James Kochan warns of upside risks in 30-year yields possibly reaching ~6.75% in scenarios, implying significant price drops.