Source: LPL Research, Bloomberg 10/30/25
Disclosures: Past performance is no guarantee of future results. Any companies or options referenced are being presented as a proxy, not as a recommendation.
Fed Balance Sheet in Focus in 2026
While rate cuts will dominate fixed income discussions in 2026, the Fed’s balance sheet strategy is also worth watching. Following its December meeting, the Fed launched temporary reserve management purchases (RMPs), buying roughly $40 billion in T-bills to maintain “ample” reserves and avoid short-term funding stress. This move is not quantitative easing (QE) per se — unlike QE, which targets longer-maturity Treasuries and MBS to lower long-term rates and stimulate growth — RMPs focus on short-term T-bills and have minimal impact on the yield curve. Purchases are expected to taper after a few months, though history suggests such programs often linger longer than planned. Nonetheless, while not technically QE, Fed liquidity reduces the chances of short-term funding market flare-ups, which have increased as of late. Moreover, the Fed is once again reinforcing the narrative that they will provide a countercyclical response to market stresses, which is ultimately good for financial markets, including the fixed income markets.
The October meeting minutes added another layer of interest, though — the Fed intends to gradually align its System Open Market Account (SOMA) portfolio with the Treasury’s issuance mix. Currently, SOMA is overweight long-duration bonds, with 10+ year maturities making up 38% of holdings versus 18% in the broader market. Going forward, the Fed plans to allocate more toward shorter maturities, reflecting Treasury’s preference for issuing debt in the two- to seven-year range. If implemented, this shift could reduce support for longer-term Treasuries, adding to volatility in the 10-year and beyond — especially as global demand for duration remains weak.
In short, while the balance sheet is no longer shrinking, its evolving composition could influence market dynamics. A shorter-duration SOMA portfolio combined with temporary liquidity operations underscores the Fed’s balancing act: easing policy without reigniting inflation, while ensuring funding markets remain stable. For investors, this means the long end of the curve may stay volatile even as short-term rates decline.
Credit View: Cockroaches, Canaries, and Zombies?
In corporate credit markets, early indicators of stress often emerge subtly — not through dramatic dislocations, but through subtle shifts in borrower behavior, isolated defaults, and nuanced changes in market dynamics. Much like the canaries once used in coal mines to detect invisible threats, corporate credit markets often serve as early warning signals for broader economic vulnerabilities.
While investment-grade bonds continue to benefit from strong technicals and steady demand, the picture is less reassuring for lower-rated issuers. Recent defaults and a rise in payment-in-kind activity suggest that the leveraged credit space is under pressure. J.P. Morgan CEO Jamie Dimon’s recent analogy comparing credit events to cockroaches — where one sighting implies many more — feels particularly apt. The public collapse late in 2025 of companies like Saks, New Fortress Energy, and Tricolor Holdings have inflicted steep losses on investors, raising concerns that these aren’t isolated incidents.
Data from Cornerstone Research underscores the trend: the first half of 2025 saw a record number of “mega” bankruptcies, with large-company filings up 81% over the long-term average. The refinancing wall looming in 2026/2027 poses additional risks, especially for companies that issued debt during the ultra-low-rate era and now face significantly higher rollover costs.
Moreover, the growing tally of “zombie companies” — mostly smaller cap companies with higher interest rate costs than income — adds to the potential for additional idiosyncratic risks within corporate credit markets. With limited relief in sight from tariffs or interest rates, these firms may face restructuring or default unless they can repair their balance sheets.
Despite these challenges, the broader credit market is not in crisis, nor do we think we are on the cusp of systemic credit issues. Our issue is with market valuations. Credit spreads, or the additional compensation for owning risky debt, remain historically tight given these rising idiosyncratic risks. Both high-grade and high-yield companies currently enjoy spreads at or near the lowest levels over the past 20 years. Only CCC-rated companies, which are the ones most prone to default, have spreads above recent secular tights. But even these spreads are only in the 29th percentile versus history, meaning spreads for these companies have been higher 71% of the time over the past 20 years. Given the increased risks but still solid economic growth, though, we expect spreads to widen somewhat from current levels but to remain below long-term averages.
Spreads for Most Credit Markets Remain Below Long-Term Averages
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