Central Banks Hold Steady as 2026 Begins

🇨🇦 Canada

The Bank of Canada maintained its overnight rate at 2.25% in December, consistent with market expectations. Governor Macklem emphasized the economy is operating near potential with inflation sustainably at target. The yield curve remains modestly inverted with 2s10s at -15bps. Provincial spreads have tightened 3-5bps as investors seek domestic yield alternatives. The January 28 meeting is expected to be a non-event with the focus shifting to April for potential further easing.

🇺🇸 United States

The Federal Reserve held the fed funds rate at 4.25-4.50% in December, citing persistent core inflation concerns. The updated dot plot suggests only 50bps of cuts in 2026, down from 100bps projected in September. Treasury supply remains heavy with $121B in 3/10/30Y auctions this week. The 10-year yield found support at 4.10% as real yields remain attractive to global investors. The curve has steepened slightly with 2s10s at +8bps.

Investment Grade

Investment-grade spreads tightened 2bps to OAS +88bps, the tightest since 2021. New issuance was predictably light during the holiday week but is expected to surge in the coming weeks with $45B forecast. Corporate fundamentals remain solid with leverage ratios stable and interest coverage healthy. Technical support continues from strong inflows into IG funds ($4.2B in December). The BBB segment has outperformed A-rated credits by 5bps over the past month.

High Yield

High-yield spreads compressed to +295bps, pricing in continued economic resilience. Default rates remain low at 2.1% (trailing 12-month) but are expected to edge higher in 2026. The CCC segment has lagged as investors favor quality within the HY space. Leveraged loan demand remains robust with CLO formation supporting prices. Energy credits have outperformed on stable oil prices near $72/bbl. Retail and healthcare sectors warrant caution due to idiosyncratic risks.

Duration Strategy

Current duration positioning should be neutral to slightly long given the asymmetric risk to yields. With the Fed on hold and inflation moderating, the risk of a significant yield spike is limited. However, the potential for a risk-off event could drive substantial rallies. Target duration of 5.5-6.0 years is appropriate for balanced mandates. Consider barbell strategies with short-term floaters and longer-dated bonds to capture curve opportunities.

Volatility & Hedging

Interest rate volatility remains elevated relative to historical norms, creating opportunities for active managers. The MOVE Index sits at 95, above the 5-year average of 85. Consider selling covered calls on duration positions to enhance yield. Agency MBS offers attractive carry with volatility embedded in the structure. Swaption markets are pricing in minimal rate path uncertainty through Q2 2026.

Where Markets Agree

• +Central banks on extended pause through Q1
• +Investment-grade credit fundamentals remain supportive
• +Yield curve to steepen gradually in 2026
• +Quality over spread reaching for income

Points of Disagreement

• ?Timing and magnitude of next Fed move
• ?HY default rate trajectory
• ?Impact of fiscal policy on Treasury supply
• ?EM vulnerability to dollar strength