Active Fixed Income Perspectives Q4 2026: Looking through the fog

Active Fixed Income Perspectives Q4 2026: Looking through the fog

Vanguard Perspective

October 20, 2026

Big picture: A justified increase in yields

What changed: Markets began the year expecting rate cuts, but have shifted direction due to a more resilient economic backdrop. This firm growth environment, combined with higher energy prices and surging global bond issuance, has forced global yields higher and increased dispersion across fixed income markets.

Why it matters: Despite ongoing uncertainty around inflation, deficits, geopolitics, and interest rates, the case for fixed income has strengthened. Higher yields provide attractive income and have materially improved prospective returns.

Rates and credit: Selectivity matters

Base case: Looking forward, we expect growth to remain strong and the labor market to remain stable. As inflation remains elevated, we expect the Fed to remove the insurance cuts delivered in 2025 while remaining sensitive to incoming data. With U.S. yields around fair value, we're neutral on U.S. duration while volatility and dispersion are creating opportunities for relative value across regions and sectors.

Mortgage-backed securities (MBS): We continue to find attractive opportunities in MBS and have increased our overweight, particularly in structures with more predictable cash flows and less extension risk.

Credit issuance surge: Record bond issuance has created sector dispersion, particularly in technology. We continue to favor investment-grade credit for its combination of yield, quality, and resilience.

Municipals: A rare opportunity

Rising yields: The Bloomberg Municipal Bond Index yielded 4.78% on September 30, a level not seen since 2008. Fundamentals remain strong and the primary drivers of this increase have been both rising Treasury yields and record supply in the asset class.

Ratios are favorable: While municipal bond yields are compelling across the full curve, the best valuations reside in the long end where the municipal AAA-to-Treasury yield ratio at 30-year maturities reached 93% as of September 30. The opportunity has attracted crossover buyers such as banks and insurance companies, supporting bond prices.

High-grade municipal yields attractive everywhere, most notably on the long end

Line chart comparing taxable-equivalent AAA municipal bond yields and U.S. Treasury yields across maturities from 3 months to 30 years. Municipal yields remain higher than Treasury yields at all maturities, with the gap widening toward the long end of the curve. At 30 years, municipal yields are approximately 8.8% versus 5.7% for Treasuries, a difference of about 3.15 percentage points. — **Source:** Bloomberg, as of September 30, 2026.

**Notes:** The municipal tax-equivalent yield is calculated using a 40.8% tax bracket, which includes a 37.0% top federal marginal income tax rate and the 3.8% net investment income tax to fund Medicare. Yield to worst represents the lowest yield possible for a security given the current price, considering both call dates and maturity.

**Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.**

Takeaways to consider:

Rates: Through mortgage-backed securities and global rates markets, opportunities for relative value and diversification have improved.
Credit: Investment-grade fundamentals remain solid, with higher yields providing attractive income even as spreads remain relatively tight.
Municipals: The backup in rates has pushed tax-exempt yields to unusually attractive levels, particularly in high-grade, longer-maturity bonds.

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