My Base Case for Why Interest Rates Could Plunge In 2026

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There are many reasons why volatility in the fixed income (bond) market can be expected to continue for the remainder of 2026. Indeed, we've only just kicked off the year, and the amount of volatility we've already seen to start 2026 has been notable.

Quick Read

• Job reports show red across the board outside healthcare, construction and hospitality sectors.

• Inflation declined from 9% in 2022 to 2.4% today, nearing the Fed’s 2% target.

• Housing costs represent over one-third of CPI as rents and property values decline.

• A recent study identified one single habit that doubled Americans’ retirement savings and moved retirement from dream, to reality. Read more here.

I think most of this volatility comes from the reality that market participants of all sizes are seeing mixed signals from hard and soft indicators. Whether we're talking about the jobs market, the U.S. dollar, inflation or GDP growth, each and every monthly report brings plenty of head-scratching. Personally, I'm not necessarily a fan of the near-term moves we're seeing in rates, but the direction does seem to want to trend lower.

Here's why I think that's the best bet to make this year for those considering adding some fixed income exposure to their portfolios in 2026.

Jobs, Jobs, Jobs

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Let's start with the jobs market for a second. That's the most important factor I think the Federal Reserve is likely to be focused on for the remainder of the year, considering the material weakness we're now seeing in most areas of the economy. Outside of healthcare and some pockets of the construction and hospitality industry (which are still somewhat recovering from the pandemic), it's pretty much red across the board every print.

And given the surging layoff announcements we're seeing (with plenty coming from the healthcare sector as well in recent months), I think these job gains are going to turn into losses in short order. On a population adjusted basis, the U.S. isn't adding enough jobs for the new workers entering the workforce. Additionally, given the cost of living constraints facing many seniors, I think a return to the job market for older folks could exacerbate an already-precarious situation for all workers and make these numbers look worse in the coming months in terms of the overall unemployment rate (which factors in the participation rate).

If the Fed leans more toward saving jobs (thanks to other risks such as AI as well) instead of battling inflation - after all, inflation isn't anything to worry about if no one has a job - then we could be due for a much lower interest rate at the front end of the curve than many expect. I'd anticipate this could bleed into the longer end of the curve, particularly if investors think these rates will stay lower for longer, once again.

Inflation Actually Falls Much Quicker Than Expected

The word inflation on a calculator on top of a stack of $100 bills

The other scenario I think most market participants are not factoring in right now is the idea that disinflationary pressures that have pushed overall inflation from around 9% in 2022 to around 2.4% today (quite close to the Federal Reserve's target of 2%) could actually be at risk of overshooting the 2% target.

One of the key reasons why this may take place is a sudden loss of faith in the U.S. market's growth potential. Much of the recent GDP growth we've seen has been tied directly to AI investment. If that investment slows, as companies look to shore up their margins and reduce Capex, that could provide recessionary forces that may lead to a self-fulfilling doom loop. We haven't seen any real indications of this yet, but that's something I'm keeping my eye on.

The other key factor I don't think gets enough attention is the reality that housing costs make up more than a third of CPI overall (and a very large chunk of GDP growth as well). If housing costs continue to come down as rents and mortgage payments decline (and property values decline as well, still the leading cause of unaffordability for new home buyers), this could lead to a sharp downturn in CPI which could force the Fed's hand.

Now, I should point out that these factors are only starting to potentially rear their heads, and we'll have to see the extent to which housing prices come down in the years to come, and if AI spending slows. But these are the two main factors I think could lead to a diminished inflation environment (regardless of tariff/trade policy) that investors aren't paying close enough attention to.

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