Jason Daw
Hello everyone, and welcome to this edition of Strategic Alternatives, an RBC Capital Markets podcast. I'm Jason Daw, the Head of North America Rate Strategy and your host for this episode. Today, we're going to examine how global interest rate cycles are evolving and what that means for markets heading into 2026. We'll look across the U.S., Canada, Europe and Asia Pacific, with insights from our regional experts, Blake Gwinn, Simon Deeley, Peter Schaffrick and Robert Thompson – to understand the factors influencing central bank decisions, the forces shaping yield curves, and how investors are interpreting signals from policy, growth, and fiscal dynamics. The conversation brings together regional perspectives to frame where the debate on rate stands now and what to watch next.
Jason Daw
So, to kick off today's episode, we're going to start in the U.S., and there's a lot of uncertainty surrounding the Fed next year. Hawks and doves on the FOMC have never sounded more divided than they are right now, and the lack of timely macroeconomic data certainly hasn't made resolving those differences any easier. So, Blake, how are you thinking about the Fed in 2026? How much are they cutting and when? And is the new Fed Chair going to shake things up?
Blake Gwinn
Yeah, thanks, Jason. So I think one thing you've rightly identified there is that the last few months, it really has seemed like we are entering a bit of a new era for the Fed, where, more specifically, we're moving away from these very well telegraphed, high consensus decisions, and moving to something where you've got a much more divided committee. Every meeting is essentially a tossup until the weeks or even days before the meeting, and also you're picking up a lot of dissent. And I think that's a function of the fact that the data right now really is kind of splitting the committee, pulling both sides of the dual mandate in opposite directions. And that's why I think you're seeing a lot of these bigger rifts. Given the fact that we have a somewhat sideways economic outlook for 2026, continued stagflationary lite type of data. You've got Trump's coming appointment of a new Fed chair, and I think you also have what's almost certainly going to be continued White House pressure on the Fed by any means possible. It does seem like this kind of new era of FOMC division and uncertainty around their decision-making process is really, probably going to continue into next year. So, what does all that mean in terms of our 2026 Fed call? I think each additional cut from here is going to be increasingly hard fought. Every 25 basis points the Fed's going to cut is going further into that neutral range. You're going to see the Hawks getting louder and louder. And I think with the current divide on the committee, they really only have to swing one or two of the centrist to capture a majority. So, all told, we have only two more cuts from here. That's the terminal rate, stopping in the 325 to 350 range, definitely short of the 3% that's currently priced in the market. And after that, I have them on hold for the rest of the year. I did want to mention this possibility of a Trump shake up. I think the impact of that has been perhaps a bit overdone. Powell is already on the dovish side of the committee, so if you replace him with another dove, it's not really going to swing the scales in a major way. And as far as delivering some of the uber-dovish outcomes, if you want to call on that, I would kind of point to the kind of outlook that's been advocated by Mirin, I really don't think a new chair is going to have the numbers to deliver those types of outcomes. So, I really think the primary impact of this new Fed Chair coming in, is really just going to be an exaggeration of those themes that we already mentioned, which is increased variation in Fed speak, more dissents and kind of more uncertainty around each meeting. But I don't think they're really going to be able to pull the needle in a much more dovish direction, single handedly, without the rest of the committee.
Jason Daw
Okay, thanks, Blake, that's obviously going to be a major theme for 2026 as far as what the Fed does and how that impacts risk assets. Now, treasury yields, they've been broadly trending lower over the course of 2025 but whether that move continues in 2026 is an open question. And one of the reasons that this past year ended up being a strong one for the Treasury market was a shift to a more dovish Fed outlook and lack of any major developments on the supply front. So, Blake, where do you see treasury yields and curves going in 2026 and why are we at a risk of a bearish supply demand narrative flaring back up?
Blake Gwinn
Overall, I think that bullish move and the steepening that we saw in 2025 – that has largely leveled out. The reality is that the Fed call I just outlined, it really isn't far enough off of market pricing or the consensus to really be a major bear driver in 2026. So, I do think it's enough, if we do see that, the Fed stopping short as we expect, I think it's enough to shift us back into the yield ranges that we saw before the negative NFP revisions in mid-2025 that really got the Fed turning dovish, marked most notably by Powell at Jackson Hole. But I don't think it's really enough to argue for this large, core short rate position into 2026. I lean towards higher yields. I probably am modestly biased towards flatter curves, perhaps just as much for the positive carry as for expectations of Fed repricing at the front end. But again, I don't think we're going to see new breakouts returning to those high yields that we've already seen in the cycle. Overall, I think 2026 likely to be a fairly range-bound environment for treasuries, as I just noted, I think it's going to really be more about tactical trading. It's going to be more about finding carry than really putting on large directional positions on either duration or curve. I think that's consistent with this relatively sideways economic outlook we have, where you've got growth that's tepid but still positive, you've got labor markets still sluggish, but not really hitting some stall speed, or not seeing this nonlinear deterioration that I think the Fed's worried about. And you've got inflation that's annoyingly above target for the Fed, but it isn't really showing signs of any meaningful acceleration. You did mention the supply outlook, and I don't really consider myself a deficit hawk on the side, but, I don't think we're really expecting a meaningful rise in term premium this year, but it is one area where I could potentially see some temporary upward yield shocks. We have penciled in some increases in coupon auction sizes for August of next year. There could certainly be some angst around the start of those increases. We saw something like that happen in late 2023 the last time Treasury embarked on increases in auction sizes. You could also see potentially some attempt at a stimulus check into the 2026 midterm elections. We've heard Trump administration kind of talking about these tariff rebates. You could see some headlines around tariff revenues, potentially getting cut off or even reversed around the Supreme Court decision, that's due on IEEPA. Or you can even see some resurgence of these de-dollarization concerns that kind of picked up around Liberation Day in 2025. But again, I don't really have a fundamentally bearish view around these things. I think we could see temporary flare ups. Definitely something I'm looking at as a bearish risk in 2026 but not really part of our fundamental core outlook. The second bearish risk I'd really be looking at is around the inflation outlook. Thus far, tips, breakevens, demand for inflation protection, very, very tame throughout 2025 but I could see a scenario where some stew of easy fiscal policy, the already delivered Fed cuts, fading of uncertainty around the trade war that really spiked around Liberation Day, some continued, gradual pass through of tariff costs, all these concerns about Fed independence. And lastly, I think, some lingering effects around immigration policies. You could see all that kind of stuff combining together and putting some upward pressure on inflation expectations. That's another kind of bearish risk that we'd be on the lookout for. As far as the bullish risk to rates pretty straightforward. I think the first is, we're just wrong about the nature of the labor market right now. We are hitting some type of stall speed, and we get into a position where the Fed is required to cut well past that neutral rate, but actually into accommodative territory. And then the second, I think, is really more market based. It's, some potential unwind of this AI capex trade that we've seen in risk assets that would drive some type of risk off flow into treasuries. So those are kind of the two primary bullish risks, I would say, the first one around the labor markets, I put a fairly low probability on and the second one, I'm pretty agnostic. I'm not really an expert in AI certainly when it comes to kind of timing any type of repricing like that. But those are the two of the risks that we are looking at in the bullish direction for next year.
Jason Daw
Thanks a lot, Blake. Moving on to Canada. Canada is facing some new realities of population growth shock, ongoing challenges from low business investment and productivity and some new opportunities on the fiscal policy front. Simon, can you elaborate on the growth outlook for Canada?
Simon Deeley
Yeah, definitely. There's new aspects going on in the Canadian economy. Population growth has gone from two to 3% in recent years to about flat this year, and that's where we expect it going forward. This is reduced the potential growth, or steady state growth run rate for the economy, a zero to 1% range from above 2%; and this is important because the Bank of Canada works off of this framework where they look at how actual growth is relative to that potential growth number for determining policy in the future. And this current environment has made GDP data especially hard to interpret because of the population side and also the transition to the new trade environment, given all the trade shocks from the U.S. For Q3 for example, we had very strong headline growth, well above consensus, at 2.6% annualized, but the details saw net trade very high due to reduced imports and final domestic demand and consumption actually flat to small negative in the quarter. And as well, there were some pretty sizable back revisions upward in general and including for nonresidential investment. So, while this could make productivity look a bit better, the general trend has been pretty weak productivity and investment numbers relative to the U.S. Now going forward, we do expect growth to move above the new low trend rate. So, for example, in 2026 we do see growth in the one and a half to 2.2% annualized range in each quarter of 2026; so, this should reduce economic slack, and even eliminate it, over the course of the year. Fiscal, as Jason you mentioned in the preamble, there will be a big factor. We've seen change in government, investment-heavy budget, and we do expect it to add about 0.3 percentage points to growth in 2026 as a whole. It could be higher, but we're taking kind of a wait-and-see approach to that fiscal lag.
Jason Daw
I'm just curious now how this all translates into the outlook for the Bank of Canada. They were on hold for a large portion of the year. They moved off the sidelines, cut in September and October, but they seem unwilling to cut further unless growth is weaker than forecast. So, what are you thinking on the outlook for the Bank of Canada in 2026?
Simon Deeley
In October, they did introduce a conditional pause to the overnight rate at 225 which solidified our view going forward, that they will keep it there through the end of 2026. And this is the lower end of their neutral range, so two and a quarter to three and a quarter is their neutral range, and they're at the bottom right now. There's certainly two-sided risks to the bank. If we get a weak economy, labor market down and a downward inflation trajectory, we certainly could see further cuts, but we don't see that as very likely. It's the lower probability of the two possible outcomes. More likely is that we get an improving growth profile that we mentioned earlier, and that leads to possible hikes even as soon as late 2026. In that scenario, inflation likely holds around 2% or even slightly above. It's worth noting as well a little bit on the balance sheet side, the bank ended quantitative tightening in early 2025, they started doing term repo since then, and will be introducing regular bill purchases starting December. However, bond purchases are not likely until 2027, so on the balance sheet side, they're a little bit ahead of where the Fed is, but on the bond purchases, they're still quite a ways to go.
Jason Daw
The bond market was a tricky animal in 2025. we had two-year yields almost 100 basis points lower, but 10 year yields were unchanged so far, and 30 year yields are a little bit higher and curves a bit steeper. So, what is the macro Bank of Canada outlook and issuance outlooks - when we combine all those, what does that mean for Canadian bonds and the yield curve in 2026?
Simon Deeley
Yeah, it's certainly an interesting environment. Monetary policy is typically the usual driver for yields and curves, given that we have a flat profile in 2026, it may be less so, but the pricing will still shift and so you do see some impact from monetary policy pricing, at least. And we do think some expected pricing of hikes in late 2026 should see some flattening of the curve, especially on the twos-five side. What we saw in 2025 was a bit of term premium related steepening. This especially at the back end of the curve, 10s, 30s, for example. And that's another possible factor in 2026 as we do, have 30-year issuance steady, while shorter tenors will see a little bit lower issuance. Overall bond issuance will still be quite high. As I mentioned, the bank will not be buying any bonds still, so issuance net of Bank of Canada purchases will remain quite elevated. And as well, Government of Canada bonds are typically impacted pretty heavily by moves in the treasury market, and this will especially be the case with that a strong monetary policy driver, and so that will be worth watching as well if upward pressure comes from the Treasury side. Overall, we do think the government of Canada can outperform treasuries as U.S. cuts are priced out, especially in the belly of the curve, so around the five year sector.
Jason Daw
Thank you. And on our world tour and this podcast, we're going to now move across the pond. Peter, let's start in the euro area and ECB. Going into 2025 you were arguing for less cuts than the market was pricing at the time. The ECB, they did one more than you thought, but by and large, less than what the market was calling for. And going into 2026 the market's still pricing some residual chance of rate cuts. What do you expect for next year?
Peter Schaffrik
Yeah, thank you, Jason. So look, trend growth has come down, but actual growth is probably going to end up north of where the reduced trend is. Unemployment is still relatively low, wage growth is probably still slightly elevated, and yes, inflation is at the ECB’s target, but they've also cut rates quite aggressively already to 2%. So, as you were saying, the market is still expecting residual rate cuts going into next year, and frankly, I have difficulty seeing that coming to fruition. You already see sort of a little bit like in the Fed, there's a quite strongly divided Governing Council, and the ECB has now communicated that there are, as they say, ‘in a good place’. So, barring any macroeconomic shock or any significant disinflationary forces that I don't foresee, I think the call for the ECB to move to a more balanced approach in their official outlook as well is very likely. And in fact, when you look at the actual outturn of the data compared to their forecasts, we reckon that in the December meeting, probably going to upgrade their forecasts anyway. So going into ‘26 then, as we get the fiscal stimulus out of Germany, the economy is probably going to do okay. I mean, the forward-looking indicators look like that. I reckon what's going to happen is that the market is going to realize, well, actually, they're done. We have to price out these residual rate cuts. And in fact, if I give you one sort of more wonky reason as well is, we also see that the money market curve can probably steepen a little, not only for these macro reasons, but probably also for some technical reasons, because in contrast to the Fed, the ECB is following a different strategy of how they provide their reserves, and we're probably getting close to the point where the reserve provision through the QE program has been running its course, and the bond portfolio is getting smaller and smaller, and then the recourse of the market will come through the repos, and the repo rate is 15 basis points above the deposit rate. So I reckon that we get more and more as the year progresses into an environment where, not only does the macroeconomic outlook say ‘All right, these guys are done, and maybe the next move is even up, and we go from pricing small cuts to small hikes.’ Also for technical reasons, the implied market rates would probably start to come from quite a bit below the deposit rate, towards the depot rate, and then maybe at some point in ‘27 even above it. So all of these reasons, for me, argue that there's very little juice left at the front end, quite a contrast.
Jason Daw
Okay, that's an interesting take, Peter. Now the UK is a different animal, it appears. Growth is probably even lower than in the euro area. Yet, the Bank of England rate is still almost double the ECB at 4% and you just changed your call for the BOE recently to three more cuts from here. What made you do that? And isn't the three and a quarter ending point still quite high in relative terms.
Peter Schaffrik
If I start at the beginning, yes, indeed, we think the UK is a different animal, as you said. So the starting point is very similar, actually. I mean, our trend, growth rate has come down, our productivity has declined, but in contrast to the euro area, we don't get a fiscal stimulus, we'll probably get some fiscal retrenchment, and the growth out turn is probably going to be below the trend number. Unemployment has been rising, and wage growth has been falling, and the Bank of England has been very adamant over the last year or so that they want to keep rates high until inflation comes down, and particularly intrinsic inflation, like the service inflation comes down, which is closely linked to wages. So, what we reckon is going to happen is inflation is going to come down. Growth is going to be weakish, and even if the labor market starts to recover, it will take some time until the slack that has built up is being reduced. So in that environment, we think that the bank, which is one of the last central banks that's running restrictive policy, can ease policy quite a bit; and the market has been scarred a little, and they will find it very difficult at the moment before the Bank of England gives the all thumbs up to price in more aggressive rate cuts. But we think that's going to come. So, we actually think the 325 and that probably goes to the last part of your question that we are forecasting, which is 25 basis points below what the forwards are currently implying is not that aggressive. When you take everything into account, I can even see an environment where there's a point in over the course of ‘26 where the market is maybe even pricing something below that. So, we actually think that the UK front end is one of the few places where we are really optimistic that positive returns can be achieved.
Jason Daw
So where does this leave you in terms of bond yields? I presume you expect the UK to outperform in relative terms, but where do you see absolute yields, and also, does the sharp curve steepening in the euro market continue?
Peter Schaffrik
I mean, despite all the idiosyncratic things that are happening, the overall outlook for yields is still determined to a great deal from the Treasury market. But as Blake was saying earlier, we as a house have not necessarily bullish view, and that obviously resonates with what I said about the ECB. So, when you think about the two largest central banks not really delivering any stimulus for the bond market relative to the forwards that will make it difficult, I would argue, for bond yields to come down. So, we actually have a fairly negative view for bond yields in particular. And on top of the lack of stimulus for bond yields to come down from the shorthand of the curve, I would argue that the steepening that we've seen in the Euro curve probably has still further to run. So, when you think about it, where did it come from in the first place? The curve started the year ‘25 from a very, very flat place, and not only because front end rates were high, but also because structurally, the ECB was still holding this very large QE portfolio that had depressed term premia, and as they were unwinding that, and as we obviously also have our own fiscal worries here, be it France, be it some of the Southern Europeans, or be it the fiscal stimulus that's going to come from Germany, we have seen that term premia going up. Now, when you analyze it, where it is currently relative to, let's say, the pre-Covid European debt crisis and GFC period, it is still way lower than where it used to be 25 years ago. So, we think there's certainly legs in the curve steepening theme, as all of these forces just continue that that were in place from ‘25 continue into ’26. And on top of that comes an extra force that is through the Dutch pension fund reform, which, in a nutshell, will probably lead to these pension fund shifting the assets out of long dated fixed income into something else. So that should probably also give you some upper pressure there. So, we have termed this the ‘inverse conundrum’, whereas the front end even though the central bank were cutting rates, didn't really lead to any lower long term rates and I think that's going to continue. So, in absolute terms, therefore, I find it really difficult to see how the European bond markets, that includes the UK, can deliver total positive total returns in absolute terms. Now in relative terms, I think you're absolutely right. We like the UK. We like it a lot, in fact. So, in cross-market trades, we like to overweight the UK. So if you want to build a portfolio where you take some long duration, we really recommend it to take it in the UK, relative to, let's say, the euro area, and in the front end of the Sterling curve, we even think some absolute gains can be achieved for all the reasons I just outlined in the question about the Bank of England. So, it's really a difference of relative versus absolute performance, and there, we think the UK is probably going to do quite well.
Jason Daw
Thanks, Peter, for the insights on the UK and the euro area. And the last stop on our world tour is Australia, and Rob, we've seen inflation pick up there sharply over the last couple of monthly and quarterly releases. Does this mean labor market considerations take a back seat and the RBA may need to look at hiking rates next year?
Rob Thompson
Hi, Jason. The pickup in the last couple of quarterly inflation reports and monthly has indeed overshadowed labor market considerations recently. But for extra context, that’s largely because the labor market picture doesn't look all that bad. If employment was truly struggling, we might not be discussing openly rate hikes at all, but stepping back into the data a little to set the scene first. The unemployment rate's been gradually creeping up towards four and a quarter, four and a half from a base of three and a half percent in late ’22, but the most recent October reading, it dipped again from four and a half to 4.3. We're not expecting it to reach much above four and a half next year either. So given four and a half might still be sub-NAIRU, our focus thus swings pretty quickly back to the inflation side of the bank's mandate, and here we're seeing a problematic picture take shape. The third quarter inflation report saw trimmed mean inflation lift to 3%, well above market expectations and our own. And in the more recent October monthly report, it looked even worse, running at 3.3% year on year. Earlier in the year inflation looked to be fading with the second quarter trim to mean down to 2.7 and the RBA’s two and a half percent midpoint target coming into site. Instead we’re now in a position where inflation is back to 3% plus. Supply side of the economy simply isn't able to keep up with the pickup coming through on the demand side and with the RBA cuttings, potential growth assumptions to only run 2% yearly against a backdrop of low productivity growth and high unit labor costs, it's looking pretty tough. A lot of concern we have with inflation is also in the composition. It's geared towards services, some particular items which tend to lead, like housing costs, which seem to be picking up again and given we also see a broadening out of private demand leading to overall activity growth in Australia well over 2% next calendar year, it's difficult to see core inflation falling back towards two and a half percent anytime soon. So, returning to the main question, will the RBA need to look at hiking rates next year? Our best case is the bank leaves them unchanged through ‘26 but we'd put the odds of at least one hike at around the 25% mark, so certainly not immaterial. Our main reasons for pouring some cold water on hikes would be that, one, the cash rate is probably already a bit on the restrictive side, at 3.6% and two, the RBA has preferred the last couple of years to take a patient, smooth approach to the rate cycle compared to lots of other global central banks that's tolerated some high short-term inflation to protect the labor market. We suspect much of this core DNA will remain in their decision making going forward, but the odds of a hike are clearly above those of a cut, and that's a big shift from us over the last couple of months, so every monthly and quarterly prints on inflation from here is going to be super sensitive for markets and inflation doesn't slow materially over the next three to six months, then the resumption of the hiking cycle will likely become the base case.
Jason Daw
Now, given the shifting in data, Australian bonds have underperformed most other developed bond markets by a considerable margin over the last few months. At what point are they wide enough to warrant another look from global investors?
Rob Thompson
Great question. Thanks, Jason. It's been a rough ride for investors in Aussie bonds lately. The benchmark 10 year spread over treasuries, has jumped from minus 20 basis points back in June to plus 20 at the start of November, now over 50 basis points. So, when's it wide enough? Well, honestly, we think there's more than enough value in there already for investors. The main issue is that there's no imminent catalyst from the Aussie side on the calendar to allow this kind of trade to perform. So, against the US, it's therefore much more around our view that US rates should sell off given to think the Fed is priced for too much, as Blake has already told us all about. And if we break down the Aussie us 10-year spread into real yield versus inflation expectations. It also doesn't seem quite right to us that Aussie real yields 40 basis points over Treasury real yields, quite apart from anything else, the Australian Commonwealth fiscal story is far less intimidating than the US Federal equivalent, which suggests that Australian real yields should be materially lower, or even below the US equivalents.
Less from a fundamental point of view and more from a markets perspective on timing, it might be a little tough to see performance into the back end of this calendar year from Aussie bonds, and instead, more likely that that could emerge as the market reopens, so to speak, in January, particularly as the traditional kangaroo issuance season hots up, which is the rush of offshore issuers hitting the Aussie dollar market for funding at the start of every new calendar year. That's the next catalyst timing wise, when you might see enough liquidity return to the market to actually see the market have some relative performance emerging.
Jason Daw
Finally, Rob, the Australian yield curve has been consistently flattening since August. Is this trend likely to continue or stall, and will domestic considerations be the bigger driver or the always high correlation with US Treasuries?
Rob Thompson
We tend towards the view that the curve can resume flattening through 2026. On the technical side, first, we know our cash rate is at 3.6% and there's no easy pricing anymore. So, our 70 basis points, 3s, 10s Futures Curve is fairly steep, and various key longer end yields, like 30-year bonds and five-year forward interest rate swaps are above the key 5% level, which will likely keep marginal flattening pressure on as investors look there for carry, rather than the more volatile front end.
One final point, there's likely to be more movement in the Fed story next year than the RBA story. So, we'll be primarily hitching your eye on Blake's view, looking for marginal flattening, driven by the Aussie correlation with Treasury curve at the forefront, and punctuated with occasional domestic-led movements, particularly as we get fresh inflation data coming through.
Jason Daw
Thank you for joining Strategic Alternatives. 2025 was a wild ride in macro and markets, and 2026 will surely see some curve balls. As the situation evolves, please reach out to directly or via your RBC sales representative for further insights. This episode was recorded on December 1st, 2025, and, for the Australia portion, on December the 3rd, 2025. Listen and subscribe to Macro Minutes on Apple podcasts, Spotify, or wherever you listen to your podcast. If you enjoyed the episode, please leave us a review and share the podcast with others.
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