Finding lower correlation in volatile markets
In a market environment with tighter spreads and geopolitical volatility rising, strategies that are diversified and offer attractive income are resonating with investors. Senior Portfolio Manager Tom Mowl explores what these assets look like
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Record AI capex requirements and the return of Fed bond-purchases are helping to shape dynamics that fixed income investors cannot ignore.
A confluence of factors are benefitting fixed income investors right now, according to Kaspar Hense, BlueBay Senior Portfolio Manager, Investment Grade at RBC BlueBay Asset Management. These, he explains, are combining to offer a favourable environment for active managers willing to sift through these securities.
Kaspar Hense
“Never has demand and supply been more important in the fixed income market, especially on the government side than in the past, with debt levels very high,” says Hense. “But also never has the fiscal and monetary policy been more joined than in the past. This is getting more intermingled at this point in time, in particular in the US.” On the monetary policy side, he points to the growing expectation that the US Federal Reserve (Fed) will return to the market soon and reignite a bond purchase programme. The fixed-income backdrop is key. 2025 has seen the US government offer more bills than bonds, relieving pressure on coupons in the latter, and instead taking advantage of cheaper debt at shorter maturities. With the Treasury needing to now stabilise that short-duration supply, Hense says he and his team expect the central bank to purchase between $250bn and $480bn in relatively longer-dated Treasuries in response to tensions he has seen in the repo market. Adding to current fixed income dynamics, Hense sees the US mega-cap tech “Magnificent Seven” (Mag7)’s significant presence in the US money market also influencing overall pricing.
In terms of what this all means for investors, Hense thinks they may be able to benefit from the current supply and demand dynamics in the fixed income universe, but there are still risks. Indeed, JPMorgan CEO Jamie Dimon recently made headlines when he warned about “cockroaches” lurking in credit markets, pointing to high profile bankruptcies as indicative of others lurking out of sight. Though Hense agrees credit markets are tight, he is more optimistic. “We think [the cockroach sentiment] is a bit overstretched at this point in time, but it's completely fair to highlight the risk and that in this higher yield environment you will see more of these happen,” says Hense. As a case in point, at this point in the cycle, Hense and his team are steering away from overly indebted sectors. This includes areas such as utilities and media with high capex needs that could have vulnerable capital structures should the market environment shift. The team are also wary of anything highly impacted by interest rate moves such as real estate, which could make them especially sensitive to rising default risk. “We are still positive on high yield but what we see [in that] market is very similar: that the spreads are tight,” adds Hense. “On an asset allocation basis, we are very conservative and looking for less indebted structures in the high yield space as well. We are shying away from CCCs and beyond.” All in all, Hense still sees a constructive investment landscape and opportunities to add alpha. Given the supportive stance taken by the Fed in particular, Hense is not anticipating a recession shock over the next six months, but nonetheless prefers a selective approach. It reminds Hense of a key RBC BlueBay mantra: “We work hard to pick out the winners, but also to avoid the losers, and it’s important to remember that these are both sides of the same ‘active management’ coin.”
A perfect storm
Finding beta, avoiding cockroaches
“The central bank is expected to purchase between $250bn and $480bn in relatively longer-dated Treasuries in response to tensions seen in the repo market”
Policy & Politics: Insights into the impact on investment decisions
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“We have roughly $10trn in US short-term government debt below one year [and] the biggest buyers of these have been these tech companies, they own a good half of the money market,” explains Hense. “There is friction in the money market - on the one side there is more issuance but on the other side there is less demand from these Mag7 companies.” Inextricably linked to the Mag7’s presence in the bond markets is the massive debt demand that is funding their Artificial Intelligence (AI) capital expenditure plans. The scale of debt issuance involved is huge: With the likes of Facebook parent company Meta “printing $60bn in a week”, Hense expects aggregate AI capex funding issuance needs to increase globally on a net basis by up to US$800bn in 2026. Putting this huge debt issuance into perspective, Hense highlights it is important to take a holistic view into how tech innovation trends are driving these markets. “We know this earnings growth will come down over time in the Mag7; it's more a question of who the winners will be and who might actually have earnings in a more monopolistic structure as we have seen in the past,” says Hense. “As a total sector, certainly the earnings will not be met and that is the valuation risk at this point in time.”
“There is friction in the money market - on the one side there is more issuance but on the other side there is less demand from these Mag7 companies”
With the US Federal Reserve recently cutting interest rates to 3.50%-3.75%, further cuts – if rapid enough – could bring new uncertainty, but also fresh opportunity, to the outlook for US fixed income.
In December, US Federal Reserve (Fed) Chair Jerome Powell announced another 25bps interest rate cut to bring its target interest rate range down to 3.50%-3.75%, the lowest since 2022. When announcing the decision, Powell pointed to a cooling labour market as the reason for the cut, where the goal of maximum employment is one half of the Fed’s dual-mandate, alongside stable prices. But with attention now turning to 2026, some bond investors are watching the central bank’s next steps even more closely.
Malin Rosengren
Malin Rosengren, RBC BlueBay Asset Management fixed income portfolio manager, is one such investor and warns that excessively quick cutting by the Fed could present challenges for an otherwise positive economic outlook. “If the Fed cuts too quickly, then you could see something similar to what we saw in the 1990s where they have to pivot back go towards hiking quite quickly thereafter, given there isn’t a no growth downturn and you have to go the last mile of the cycle,” says Rosengren. “It's hard to get inflation down to target without a growth downturn. This is quite an unusual cycle where you do have both monetary and fiscal policy quite loose, and growth still well supported.” As such, Rosengren sees any Fed rate as lower than 3% as drawing concern over a potential “a policy misstep”. Given the Fed’s recent preference for cuts by 25bps cuts, and the lower end of the bank’s target interest rate range is already at 3.50%, this territory could be as close as the Fed’s March meeting, following the Fed’s first meeting of 2026 in late January. While the rate outlook remains a risk, it is not unusual for the Fed to have to grapple with such policy deliberations. Rather differently however, there is another risk which could be approaching for the US central bank, with Powell set to step down in May, which could be altogether much less familiar for markets.
Against this uncertain backdrop, Rosengren and her team are busy focusing on alpha and trying to identify and take advantage of asymmetry in the market. Tight valuations mean an active approach can help to identify such opportunities and take advantage of volatility as and when it appears. For the US, a particular challenge has been navigating the recent US government shutdown back in October-November, and the corresponding air-pocket in top-down data. “It’s more challenging for policymakers – and the market in general – to have a transparent read on the economy”, highlights Rosengren. Yet if this data gives rise to pricing discrepancies, Rosengren and her team will seek to try to take advantage of them. Beyond the US and developed markets, also on Rosengren’s radar are Emerging Markets. “We're looking for areas which have more attractive valuations or where higher volatility has opened up trades – such as Latin American countries going into election cycles,” explains the portfolio manager. “We’ve been more active in the local rates space where we're seeing more opportunities rather than just credit, given valuations.”
A nearing “policy misstep”
The risk of Fed independence
“An increasingly politicised Fed could risk introducing a new way in how monetary policy could be influenced – as well as interpreted by the market”
Scrutiny of the Fed has become increasingly politicised, with US President Trump a regular critic of the Fed’s decisions in 2025. The result is that an increasingly vocal White House has only fuelled more and more uncertainty around the future of Fed independence. This has led some investors to expect Trump to position his preferred candidates to replace Powell – such as his economic adviser, and National Economic Council director, Kevin Hassett. “If Hassett does come in and tries to instil a bigger non-recessionary easing cycle, then the market would very likely react,” says Rosengren “Depending on scale of the policy trigger, you could see a steepening curve and, with it, renewed questioning of the central bank's credibility, in all risking a weaker US dollar which would be inflationary.” It remains to be seen who replaces Powell, but an increasingly politicised Fed could risk introducing a new way in how monetary policy could be influenced – as well as interpreted by the market. Rosengren says this is “critical” for bond investors and could inspire a return of the debasement trade and divestment from the US seen in 2025. “The outcome wouldn’t do much to help with affordability issues in the US. Dollar weakness would further add to inflationary pressures while a steeper yield curve would continue to subdue the housing market,” adds Rosengren. “This brings us to mid-terms where Trump has been more concerned over affordability, given he’s lost voter support over the issue. It’ll be a test to see what’s more important.”
Finding the right opportunities
2025 was an eventful year, with tariff-led market volatility in April giving way to a calming of trade tensions. Key investment themes during the year included a weakened US dollar, EM strength, rising defence spending in Europe, and shifting geopolitical alliances. In 2026, AI continues to be a leading theme and dominates headlines, as technological innovation transforms sectors and influences capital expenditure and growth. With economic regime changes underway, the world continues to look uncertain, and skilled active managers should have ample opportunity to generate outperformance. Read about RBC BlueBay's approach to global markets in 2026 by clicking on the links below.
Mark Dowding, BlueBay CIO
Global Fixed Income
“The US deficit is projected to decrease slightly in 2026, thanks to increased tariff revenue. However, concerns about long-term debt sustainability remain, particularly in countries like the UK and France”
Download RBC BlueBay's Global Market Outlook
Polina Kurdyavko, Head of Emerging Market Debt
Emerging Market Debt
“In addition to the improving fundamental outlook in EM, we believe the technical tailwinds will remain in play in 2026, as investors seek to diversify their portfolios away from core markets, and global investors, who remain under allocated to the asset class, search for diversification and yield pick-up…”
Jeremy Richardson, Senior Portfolio Manager
Global Equities
“There are reasons to be optimistic about the outlook for 2026. Earnings estimates are forecasting another year of double-digit EPS growth, and if multiples stay where they are, this should lead to satisfactory returns for equity investors…”
Sid Chhabra, Head of Securitised Credit, CLO Management and European High Yield
High Yield
“AI remains a key theme, both as a source of capital expenditure funding and as a driver of opportunities and challenges across industries. The best of private credit will continue to transition into public markets as companies seek to diversify their lender base...”
Read the full market analysis
Markets are still growing accustomed to heightened uncertainty across a range of issues as the US adopts a more muscular, unilateral, and transactional approach to trade, international conflicts and its own alliances. Below, RBC BlueBay explores developments from last year to pick out trends that might persist in the future and examine where the likely flashpoints could arise in 2026.
Few Asian countries wish to make an outright bet on Washington or Beijing, as many fear the consequences if the geopolitical rivalry gets out of control. So far, most of their diplomatic rhetoric remains calculated and conciliatory to both China and the US, hedging their bets in the hope of retaining their own strategic autonomy. India views itself as a major power that is too significant to be aligned either with US or China. It seeks to play them off each other to maximise its own strategic leverage. For example, when the border dispute with China intensified, India joined the Quadrilateral Security Dialogue (Quad) along with Australia, US, and Japan. When Trump imposed 50% tariffs on India for importing Russian crude, Modi swiftly made an appearance at the Shanghai Cooperation Organisation summit, a China and Russia-led regional security organisation, to pose solidarity with Putin and Xi. Looking ahead, Modi’s BJP faces important state elections in 2026, which should shed light on his domestic footing and the strength of his position in forging global geopolitical alliances. Perhaps the most important events in 2026 will be China–US bilateral meetings, with Trump visiting Beijing in the spring and Xi to Washington later in the year, which should in theory anchor relations and offer a higher level of predictability.
Latin America
Europe is now realising, perhaps too late, that not only its values but its interests might diverge from Trump and MAGA
Click to explore each region in more detail, with insight on: How US policy could impact other EMs The key risks in 2026 The potential for high levels of differentiation in EMs
Latin America emerged relatively unscathed from the Liberation Day tariff announcements. The baseline 10% was applied almost uniformly. Mexico merits particular attention because its economy is most closely integrated with the US and because the US-Mexico-Canada Agreement (USMCA) trade agreement is such a key consideration. For other countries, though, it quickly became apparent that alignment with US priorities was a wise strategy. Colombia learnt this the hard way as early as January, when President Petro’s late-night complaint about the treatment of his deported compatriots immediately prompted the imposition of a 25% tariff on all the country’s exports to the US. The Brazilian government, meanwhile, was careful not to antagonise the Trump administration, but was punished regardless with 50% tariffs when its independent judicial system followed through with the prosecution of former president Jair Bolsonaro for his coup plot after he lost the 2022 election to Luiz Inácio Lula da Silva (Lula). A review of USMCA is due to conclude by mid-2026, but uncertainty over the future trading relationship will nevertheless remain high, undermining investment. We also expect the US push to chip away at China’s influence to remain a theme for the region in 2026.
Asia
Despite warm word of appreciation at the White House and grand state visits there is little doubt that Trump’s second term has ushered in a foreboding in Europe that his agenda is not only to disengage militarily from Europe, but to drive his own interests and priorities, including a focus on China (not Russia) as the prime global threat. Interests, not values, drive the Trump agenda, anathema to a European project which prides itself on supposed common values that it has tried to export via enlargement and trade policy. But Europe is now realising, perhaps too late, that not only its values but its interests might diverge from Trump and MAGA. However, even within Europe, there are competing political forces. Reform in the UK, the AfD in Germany, National Rally in France, Orban in Hungary, Fico in Slovakia, Nawrocki in Poland, and even Babis in the Czech Republic align more closely with Trump and MAGA. We have seen the rump European mainstream try and deploy (and withhold) resources to try and hold the line in defence of European social liberalism. In Romania and Moldova, this would suggest favourable treatment (and ample funding) from the European Commission towards new governments facing difficult reform challenges – much-needed fiscal consolidation in the case of Romania. Albania, Bulgaria, and the Tusk government in Poland get similarly favourable treatment from the EC. The future of stalled EU structural funds could shape hard-contested elections looming in Hungary in April 2026, while we will also be watching potential early elections in Serbia. In the Gulf, states are expected to continue opening up and reform agendas, and Trump’s effort to freeze Russia out of international oil markets could be an opportunity for Gulf producers.
CEEMEA
Sub-Saharan Africa
The Trump administration hasn’t tended to prioritise Sub-Saharan Africa, as the region is neither a major trading partner nor a geopolitical competitor. Cuts to aid in some ways evidence the less-than-positive focus on the region and contrast sharply with the support offered to nations such as Argentina. However, with the US seeking to source rare earths and compete with China, we have seen evidence of US intervention in the region where these policy priorities have some crossovers. Trump invited DRC and Rwanda to sign a deal to halt the conflict in the eastern DRC that involved Rwandan-backed troops. While there is uncertainty over the long-term success of the deal, it appears the Trump administration is seeking to calm the region and gain access to the DRC’s endowment of rare earth minerals. This may have other positive spin offs via investment into the region, but that is not guaranteed, and we have seen many examples of resource rich nations exporting commodities but failing to raise living standards for the population, due to weak governance and poor policy choices.
Few Asian countries wish to make an outright bet on Washington or Beijing, as many fear the consequences if the geopolitical rivalry gets out of control
Richard Farrell
It’s true that the performance of China and India often mirror each other, and there are some fundamental reason for this. First, 60% of India’s GDP is driven by consumption, one of the highest in EMs. In contrast China’s economic growth has been driven by investment funded by debt. Over the last 20 years this has meant the Indian stock market has been more of a secular consumption growth story, whereas China’s has been more cyclical dictated by the government policy. Another difference is the cost of capital. India has historically had a relatively insulated protectionist economy and a large bureaucracy, which has resulted in structurally higher inflation and a higher cost of capital. China in contrast has a much lower cost of capital due to its mercantilist, low friction economic strategy. This has resulted in structurally higher return on equity in the Indian market versus China China due to this higher cost of capital. In the last 10 years however, the Chinese stock market has gradually shifted to technology and internet related stocks whereas the Indian stock market has no meaningful AI story and remains dominated by financials and consumer sectors. This means that in 2026 China and India’s relative performance is likely to be driven by AI one way or another.
Two areas we are invested in that we expect will benefit from this trend but believe is currently underappreciated by the market, are electric vehicles and travel. EV penetration is still extremely low in India, but as the cost of EVs comes down and disposable income increases, we expect accelerating sales, especially in more affluent urban areas where charging infrastructure is more developed. We also expect demand for experiences such as travel and tourism to grow rapidly helped by the rapid growth of India’s airline and hotel industries.
India has been positioned as a counterweight to China in recent years. Is this still the case in 2026?
Can India sustain its 6–6.5% growth?
Retail inflows [have] pushed valuations beyond realistic growth expectations, especially in the small and mid-cap space
In terms of GDP per capita, India is starting from a low base. Since 2014, the government has introduced several economic reforms such as the Aadhaar digital ID programme, demonetisation, and the Real Estate Regulation and Development Act, all designed to reduce fraud and tax evasion. They also introduced the Goods and Services Act to reduce and streamline inter-state tax collection and updated the Insolvency and Bankruptcy Code to clean-up bad debts in the financial system. All these measures have helped to liberalise the economy, lower inflation and increase growth. To continue to grow the economy above 6%, the Indian government needs to focus on the industrial sector, particularly manufacturing. The Make in India programme is designed to do just that, increase India’s manufacturing share of GDP from 16% to 25% by 2030. To do this, the government needs to continue to invest in infrastructure.
Which underappreciated sectors could benefit most from India’s premiumisation and rising demand for services and experiences?
Is India’s valuation premium still warranted?
India has historically traded at a premium to the rest of EM because of its higher growth and return on equity. However, in 2024 we went underweight India for the first time since the inception of our EM Equity fund in 2010, purely on concerns around valuation. We felt retail inflows had pushed valuations beyond realistic growth expectations, especially in the small and mid-cap space. Since then, valuations have moderated as the economy has cooled and retail flows have slowed but are still above long-term averages. We do see pockets of attractive valuations however, particularly in financials and IT services. That said, we do think that India’s fair value is at a premium to other EM markets, not only because of its superior growth and returns, but additionally its relative political stability. Modi’s BJP party did lose its overall majority in 2024, but its NDA coalition did manage to maintain control. This means investors can expect policy continuity for at least another 4 years.
For advisers building EM exposure, should India be a core holding or more of a tactical play?
As long-term investors focused on areas of long-term structural growth, we very much see India as a core part of our EM portfolio due to its emerging middle-class. If valuations improve or growth accelerates again, we will go overweight India. Being overweight India for most of the life of the fund has served us well. In the short-term risks centre around geo-politics as the Modi government tries to maintain a neutral stance between the US and China. The recent trade deal with the US has reduced this risk for now but stopping Russian oil purchases may negatively impact the economy this year via higher inflation. The main risk to the long-term investment thesis is if the government’s economic reform agenda stalls, particularly as it relates to the Make in India initiative. Vitalising India’s industrial base is critical to generating enough new jobs for the roughly 10 million new graduates per year, especially in the context where AI could jeopardise entry level knowledge work in the IT services industry. From a longer term perspective, we continue to view India as one of the most compelling structural stories in EM. The country offers superior growth prospects given its attractive demographics and low penetration rates across many areas. India has the lowest urbanisation rate in EM, but rapid growth is expected, from around 30% today to over 50% by 2050. Meanwhile, from a bottom-up perspective, the quality of corporates really stands out with a higher proportion of compounders and superior Return on Equity compared to other EMs.
In 2026, China and India’s relative performance is likely to be driven by AI one way or another
In a market environment with tighter spreads and geopolitical volatility rising, strategies that are diversified and offer attractive income are resonating with investors. Tom Mowl, BlueBay Senior Portfolio Manager, Securitised Credit & CLO Management explores what these assets look like
Tom Mowl
Yes, we are seeing increasing interest from investors looking for alternative asset classes that offer lower correlations to more traditional fixed income and equities. In securitized credit, across the risk spectrum the asset class provides exposure to alternative sources of risk, such as consumers, alongside having low interest rate duration which makes the asset class a good complement to traditional assets. Investors are seeking predictable and alternative sources of carry with structural protections. In the liquid high grade space, strategies can play a key role as cash enhancement vehicles offering an attractive spread pick up, very high credit quality and low drawdowns. Investment grade securitized provides an attractive complement to traditional IG corporates; with diversified strategies offering shorter spread duration, floating rate exposure, an attractive spread pick up and protection from single name stress alongside high credit quality. In the illiquid space, strategies investing in capital call loans are gaining traction as a diversifier to corporate risk factors, here exposure to tier 1 sponsors can provide very high quality risk with an attractive spread pick up vs IG assets driven by the illiquidity premium.
When it comes to liquidity investors always have a need for liquid assets, and in that space securitized credit offers a compelling solution given the attractive spread pick up even in the very liquid high quality part of the capital structure. Some investors are willing to have lower liquidity allocations and in some cases lock up capital, but the demand for an appropriate spread pick up has increased. In areas like direct lending for example, we have seen a trend of spread compression versus the public broadly syndicated loan market which suggests the illiquidity premium is not as compelling. There is demand for high quality assets that offer a spread pick up and some investors are willing to move into illiquid assets to access the premium, and here capital call loan strategies can provide a unique solutions.
Are institutional investors becoming more interested in decorrelated assets than before?
Between systematic macro, market-neutral, ILS, and alternative income, which is currently the most popular choice for diversification, and what is the main reason why?
In our experience, investors are looking for asset classes that can complement their existing asset allocations, offer lower correlations, and provide an alternative source of income
From our perspective, we are seeing alternative income as a key theme resonating with institutional investors. In a market environment with credit spreads on the tighter end, periods of volatility and rising single name stress strategies that are diversified, active and offer attractive income are resonating with investors.
Do investors currently prefer the quick liquidity of strategies like systematic macro, or are they more willing to lock up capital in alternative income to get higher returns?
Is the shift toward these niche strategies driven by a need to protect against market crashes, or are investors simply looking for new sources of yield that don't depend on the economy?
We wouldn't refer to securitized credit as a niche strategy, given the market size is multiple trillions and growing. Ultimately the asset class will be driven by broader macro moves, but the compelling characteristics such as short spread duration, strong collateral and structures, protection from single name credit events and natural de-leveraging offer compelling benefits versus traditional credit. The capital call loan space is a more niche strategy, whilst it's a large market it has traditionally only been banks that have access. The increase in strategies offering this as a unique solution is very compelling for institutional investors as an alternative source of income in very high quality assets that are not linked to broader credit and equity.
Given the current geopolitical volatility being seen in some areas, what sort of market environments does this asset class work best?
In our experience, investors are looking for asset classes that can complement their existing asset allocations, offer lower correlations, and provide an alternative source of income. Uncertainty is likely to remain high this year, however our outlook for securitised credit for 2026 is positive. Ultimately the asset class will be driven by broader macro moves, but its compelling characteristics such as short spread duration, strong collateral and structures, protection from single name credit events and natural de-leveraging offer compelling benefits versus traditional credit.
There is demand for high quality assets that offer a spread pick up and some investors are willing to move into illiquid assets to access the premium...
