Fixed income in focus: finding value in today’s inflationary landscape

Global markets continue to be viewed cautiously by investors, shaped by concerns around persistent inflation, the prospect of central bank interest rates rising, or at least staying higher for longer, and ongoing fiscal pressures as governments issue large volumes of debt.

Questions around policy credibility, central bank independence and the risk of stagflation add to the sense of uncertainty. Against this backdrop, Ewan McAlpine, Investment Director at Royal London Asset Management, explains why understanding where the key risks lie – and how they can be managed – is essential to identifying how fixed income can still play a valuable role in client portfolios.

A challenging and uncertain backdrop

Following the fall in inflation rates from the highs of 2022/2023, inflation has proven more persistent than expected and, more recently, has seen near term expectations rising, pushing yields higher and challenging the long‑held assumption that bonds reliably provide capital protection during periods of market stress. While policy rates have normalised somewhat, they remain elevated, and concerns around interest rate sensitivity and duration risk remain front of mind.

Alongside inflation, fiscal dynamics add another layer of uncertainty. Governments are issuing large amounts of debt to fund spending, raising questions around debt sustainability, the credibility of long‑term borrowing plans and the extent to which central banks can maintain independence while meeting their primary mandate of controlling inflation. This is in an environment where there is the possibility of a negative growth shock as a result of higher energy prices and hindered global trade. As investors demand greater compensation for holding longer‑dated government bonds, but given likely volatility, long duration exposure has become less attractive in this environment.

In credit markets, spreads remain tight by historical standards, leaving a bias in expectations should growth disappoint or sentiment shift; although they have proved resilient in recent months, risk of widening is ever‑present, particularly in an environment where economic growth remains anaemic and the possibility of stagflation cannot be ruled out. Taken together, these factors suggest this is not an environment for complacency or broad, passive exposure to fixed income. Selectivity and risk awareness are essential.

Is inflation a concern?

UK index linked gilts (linkers) provide investors with explicit inflation protection alongside exposure to real interest rates.  After a prolonged period of financial repression, real yields in the UK have reset meaningfully higher and now sit at levels that look attractive on a long-term historical basis. With the direction of travel for interest rates increasingly downwards, however there is a risk for near-term hikes, linkers offer the potential for capital gains through falling real yields, supported by a favourable supply backdrop and continued macro and geopolitical uncertainty. In this environment, dispersion across maturities, breakevens and markets is elevated, reinforcing the case for active management.

For many investors, linkers serve several distinct purposes. Linkers provide a direct hedge against inflation outcomes that exceed expectations, making them a natural component of portfolios with inflation sensitive liabilities or real return objectives. By separating nominal rate risk from real rate risk, linkers diversify traditional gilt exposure and can behave differently to nominal bonds during periods of inflation volatility. Linkers retain the convexity and duration benefits of long dated government bonds, while offering protection against upside inflation risks.

It is also important to note, lower net supply of long dated and index linked gilts reduces the amount of duration risk the market needs to absorb, providing technical support to valuations, particularly at the long end of the real yield curve. Although index linked gilts are often perceived as a buy and hold asset class, in practice they offer opportunity for active value add, particularly in the current environment. Movements in real yields are rarely uniform across maturities. Supply dynamics, pension demand and technical factors can lead to persistent mis pricings along the curve. Inflation expectations can become disconnected from underlying fundamentals, particularly during periods of energy price volatility or geopolitical stress. Switching between nominal gilts and linkers can add value when real yields and breakevens move out of line with economic realities.

Income changes the narrative

Despite these risks, the opportunity set within fixed income has materially improved, particularly from an income perspective. Higher yields now exist across much of the curve, allowing investors to generate attractive levels of income-driven returns. For many portfolios, simply harvesting income can now be a meaningful contributor to total return.

Short duration strategies stand out in this context. They offer attractive carry with lower sensitivity to interest rate volatility.

At the same time, dispersion across markets, regions and sectors has increased. Differences are more pronounced in times of heightened volatility, creating inefficiencies that active managers are well placed to exploit. Careful security selection and portfolio construction can look to add value beyond what passive exposure can expect to deliver.

Positioning for resilience and flexibility

While it’s hard to predict what may come next – market direction and level is changing meaningfully every day – it’s safe to expect such continued volatility fuelled by higher energy costs that will, at best, take some time to normalise, and limited prospects for a strong growth recovery. In this environment, making large directional calls on bond markets. Instead, a more flexible, duration‑aware approach is likely to be better suited to current conditions.

Shorter‑dated, high‑income strategies can help mitigate interest rate risk while maintaining resilience and cashflow generation. Credit remains an important component of this approach, supported by income fundamentals even as macroeconomic uncertainty persists. While spreads are tight, income continues to provide a cushion against volatility, provided exposure is managed carefully and risks are well understood.

Ultimately, success in fixed income will depend on balancing income generation with prudent risk management. In a world where certainty is scarce, income has reasserted itself as the most reliable feature of fixed income returns. For advisers, the challenge is not whether fixed income still has a role to play, but how best to position it to deliver resilient outcomes for clients.

This feature was part of our 2026 Fixed Income Insights. For deeper analysis on bond markets and rates strategy for advisers, explore IFA Magazine’s latest Fixed Income Insights publication.

About Ewan McAlpine – Investment Director    

Ewan joined Royal London Asset Management’s Fixed Income team in 2012, bringing with him extensive experience in asset management and bond markets. After graduation, he spent a number of years as a scientist before beginning a career in finance in 1993, initially with the London Stock Exchange, and subsequently with a number of major asset management firms. Prior to joining, Ewan was a Portfolio Manager at Rogge Global Partners. Ewan has a degree in Applied Physics from the University of Strathclyde.