- Financial markets continue to rally amid some concerns about the real economy.
- Central banks are also turning neutral, a few even a tad hawkish.
- Some inflation complacency is likely in play.
- Fed independence is a key risk.
- Asia rates face challenges from stretched valuations.
Click here to read the full report
Rates direction for 2026 will depend on the evolution of some of the key themes that have been at play over the past several quarters. Divergence between outperforming financial markets and some slowing of the real economy, the global inflation call, central banks’ policies, and Fed independence will be the critical issues to watch. Below, we lay out our considerations for each theme, offering some thoughts on how things will play out and how rates are priced. We would also keep a wary eye on geopolitics as the US’s strikes on Venezuela could well have economic / financial implications, and thus, interest rates.
One, the so-called “K-shaped economy” in the US. Many of the economic indicators suggest that the US economy is growing reasonably well. However, there is noticeable weakness in hiring over the past few months. The other K-shaped phenomena to monitor would be stocks (up) vs Trump’s popularity (down), which may trigger more fiscal loosening with the mid-terms upcoming. There are a few ways this could play out. A benign scenario would be one where the AI / tech optimism spreads to the other sectors and eventually leads to broad based growth and hiring restarts. This would drive US yields higher, catching up to stocks. Conversely, if optimism in the tech space proved unfounded and labour market weakness persists, a deeper Fed cut cycle would be priced. Risks are balanced and it would take some time for things to play out. We lean on the optimistic side, anticipating that longer-term USD yields would generally drift higher through 2026.
Two, the issue of Fed independence will be heavily debated with concerns about the appointment of the new Fed Chair. Market participants will also be watching to see if Governor Cook gets removed. Some premium on the former is already reflected in frontend USD rates where more rate cuts are factored in 2H26 (beyond May where Fed Chair Powell steps down). While not our base case, if the Fed gets compromised, rates will be meaningfully lower than where they should be relative to what economic conditions warrant. A collapse in frontend USD rates and a second order spike in inflation expectations (and a much steeper curve) may well ensue.
Three, G10 central banks are on average turning hawkish. 2025 was a clearer theme where G10 central banks excluding the BOJ embark to easing. However, with significant cuts delivered over the past few quarters, many of the central banks are already close to, if not already at, neutral. Some easing is expected from the Fed and the BOE but for the rest, a neutral to hawkish bias may start to take hold. This transition (from largely dovish to a neutral / hawkish stance) may well point to upward pressure in belly tenor yields across the DM.
Four, the benign inflation backdrop may not last. Economic activity across the globe has been firm despite the Liberation Day shock. Moreover, oil prices have been contained. In the US, tariff-led inflation has been more than overshadowed by falling shelter prices. For the rest of Asia, contained food, oil prices and challenges to the China’s economy have also driven CPI generally lower. We think some complacency may be starting to show up. If capital expenditure ratchets up or the much-touted trade hangover from frontloading fail to materialise, inflation risks may be skewed higher. We will be watching commodity prices closely.
Five, Asia LCY rates valuation are tight and bear watching. While conditions (and consensus) appear to favour further Fed easing and USD weakness, we are also wary on risks. Asia LCY rates have outperformed on average versus G10 rates over the past couple of years. 2025’s Asia LCY rates outperformance has left spreads over the G10 counterparts at compressed levels. There seems to be little margin for further outperformance and investors should be watchful of an upward shift in gravity in DM rates that could impact LCY Asia rates. Domestic Asia inflation risks and a resurgent USD are also key risks to watch.
Taken together, the rates space looks likely to face a tougher backdrop amidst uncertainties over the K-shaped economy, a transition towards a neutral / slight hawkish stance across the G10 and immediate term geopolitical concerns. For Asia, rich valuation is a challenge.
Click here to read the full report
Topic
GENERAL DISCLOSURE/ DISCLAIMER (For Macroeconomics, Currencies, Interest Rates & Digital Assets)
The information herein is published by DBS Bank Ltd and/or DBS Bank (Hong Kong) Limited (each and/or collectively, the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction (including but not limited to citizens or residents of the United States of America) where such distribution, publication, availability or use would be contrary to law or regulation. The information is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction (including but not limited to the United States of America) where such an offer or solicitation would be contrary to law or regulation.
[#for Distribution in Singapore] This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) which is Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, DBS Bank Ltd accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact DBS Bank Ltd at 65-6878-8888 for matters arising from, or in connection with the report.
DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.
DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability. 18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.
DBS Bank (Hong Kong) Limited, a company incorporated in Hong Kong with limited liability. 11th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.
Virtual currencies are highly speculative digital "virtual commodities", and are not currencies. It is not a financial product approved by the Taiwan Financial Supervisory Commission, and the safeguards of the existing investor protection regime does not apply. The prices of virtual currencies may fluctuate greatly, and the investment risk is high. Before engaging in such transactions, the investor should carefully assess the risks, and seek its own independent advice.