- Near-Term Momentum: Growth is likely to remain positive in 2026, with recent data suggesting the potential for firmer momentum, even as longer-term risks point toward moderation later. Strong balance sheets, rising financial asset price support, and improving manufacturing activity underpin growth. At the same time, the durability of this acceleration remains uncertain, raising the possibility of potential boom/bust dynamics unfolding at some point.
- Muted Job Market: Labor market conditions have softened, reflecting increasingly K-shaped dynamics. While unemployment claims remain low, signaling limited consumer and corporate stress, recent layoff announcements appear noisy rather than systemic. A period of “no hiring, but no firing” among corporations may eventually cap the pace of expansion, but it has not yet translated into broad labor market weakness.
- Consumption Narrowing: Consumer spending remains a key growth driver, but its durability increasingly depends on a shrinking base. Higher income households continue to spend, particularly on services, while depressed consumer confidence, tighter budgets, and slower wage growth among middle and lower income consumers restrain overall consumption growth.
- Inflation Moderating: Inflation is likely to continue to moderate even as progress toward the Fed’s 2% target remains uneven and gradual. History suggests that economic cycles rarely experience a single, clean wave of inflation, and while near-term pressures appear contained, the risk of a future resurgence, perhaps driven by policy dynamics, cannot be ruled out.
- Demographic Headwinds: Slowing population growth is likely a longer term structural constraint on economic growth. Falling birth rates, rising deaths, and the move toward negative net migration, exacerbated by mass deportations, are likely to shape labor supply and potential growth over time. These secular forces may become more influential as cyclical tailwinds fade.
- Productivity Offset: Productivity gains offer a potential counterbalance to slower labor force growth, particularly through AI-related investment and automation. Recent strength in capital spending and corporate earnings suggest productivity gains could support growth in the near term, even as the scale and durability of these gains remain uncertain.
- Positioning Reflects Balance: Touchstone maintains a full allocation to fixed income, with a tactical overweight to U.S. investment grade bonds and a neutral duration stance focused on the intermediate part of the curve. Recent bond market returns have been relatively strong yet yields remain attractive compared with much of the past decade. Together with a slowing but resilient economic backdrop, this supports fixed income’s role as both a source of income and portfolio ballast, while elevated uncertainty argues against aggressive duration positioning.
- Policy on Hold, Uncertainty Rising: With the Fed pausing rate cuts at its latest meeting, near-term policy rates appear anchored. However, uncertainty around the policy path later in the year, including leadership transition risk tied to the Kevin Warsh confirmation process, has widened the range of potential outcomes for interest rates.
- A Less Certain Reaction Function: Kevin Warsh’s past emphasis on fighting inflation, contrasted with more recent support for lower interest rates, introduces some uncertainty around the Fed’s future reaction function. This incongruity may complicate his role as a consensus builder, increasing the potential for repricing at the front end of the curve as markets reassess the timing and pace of policy moves.
- Long End Term Premium Pressures: The nominee’s prior preference for balance sheet discipline and reduced reliance on quantitative easing may portend limited structural support for long-duration Treasuries. Combined with elevated fiscal supply and political uncertainty, this backdrop raises the risk of higher term premia and increased volatility at the long end of the curve.
- Belly Offers the Best Risk-Reward Potential: With risks elevated at both the short and long ends of the curve, the intermediate maturity segment offers a more balanced risk-reward profile and attractive roll-down potential, the incremental return generated as bonds naturally age and move down the curve over time. Focusing duration exposure in this part of the curve allows investors to capture income and defensive characteristics while limiting exposure to policy driven volatility, reinforcing the case for a tactical overweight to high quality fixed income.
- Credit Returns Supported by Income: Corporate and securitized credit posted constructive returns to start the year, driven by carry, despite ongoing rate volatility. We maintain a full allocation to fixed income with a bias toward high quality, alongside meaningful strategic exposure to below investment grade sectors that continue to contribute to total return. We see credit markets moving from a period of supply scarcity toward a higher issuance environment, increasing the importance of selectivity.
- AI-Related Issuance a Key Risk to Monitor: Expectations for elevated issuance tied to hyper-scalers, data centers, and AI-driven infrastructure are a central theme for 2026, reinforced by a pickup in large scale M&A. While these issuers generally have strong balance sheets, the scale and concentration of supply raise questions around market absorption, index composition, and correlation risk. Demand for high-quality credit remains solid, but clearing heavier issuance is likely to require concessions, shifting the market toward a more buyer friendly regime.
- High Yield Quality Better, Dispersion Higher: The growth of private credit has left the public high yield market higher quality on average, but more uneven beneath the surface. Defaults remain muted and stress is largely idiosyncratic, yet weaker issuers continue to face widening spreads and pressure on fundamentals. As restructurings and liability management activity become more prominent, active management remains critical to navigating credit selection and capital structure risk.
- Bank Loan Technical Factors Less Supportive: The bank loan market posted negative returns in January as spreads widened and the tailwind from higher short-term rates faded. With the Fed on hold and potential easing possible later in the year, floating-rate instruments may offer less relative advantage.
- Constructive but Increasingly Selective: Consistent with the economic backdrop and a more balanced rate environment, Touchstone remains constructive on credit return potential. However, the shift from scarcity to supply, rising dispersion, and sector-specific risks reinforce the need for quality, active security selection, and vigilance. In a K-shaped world, credit markets are defined less by broad stress and more by differentiation, an environment that can reward disciplined investors.
Fixed Income Indexes Characteristics
The Indexes mentioned are unmanaged statistical composites of stock market or bond market performance. Investing in an index is not possible.
For Index Definitions see: TouchstoneInvestments.com/insights/investment-terms-and-index-definitions
2022 – The Fed embarked on one of its most aggressive tightening paths seen in decades as the inflation rate surged well above their goal. Interest rates rose across all maturities leading to one of the worst years for fixed income returns.
2023 – Inflation fell broadly while the economy grew with the labor market and consumer spending resilient. The Fed paused midyear helping rates and credit spreads fall late in the year and turning returns positive for the year.
2024 – Economic growth continued unabated, driven by consumer spending. Inflation moderated further. The Federal Reserve pause continued until September, after which it cut interest rates three times by a total of 1 percentage point. Bond yields rose in response, resulting in only modest gains for high quality fixed income but better returns for riskier areas of fixed income.
The Touchstone Asset Allocation Committee
The Touchstone Asset Allocation Committee (TAAC) consisting of Crit Thomas, CFA, CAIA – Global Market Strategist, Erik M. Aarts, CIMA – Vice President and Senior Fixed Income Strategist, and Tim Paulin, CFA – Senior Vice President, Investment Research and Product Management, develops in-depth asset allocation guidance using established and evolving methodologies, inputs and analysis and communicates its methods, findings and guidance to stakeholders. TAAC uses different approaches in its development of Strategic Allocation and Tactical Allocation that are designed to add value for financial professionals and their clients. TAAC meets regularly to assess market conditions and conducts deep dive analyses on specific asset classes which are delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800.638.8194 for more information.
A Word About Risk
Investing in fixed-income securities which can experience reduced liquidity during certain market events, lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. Investment grade debt securities which may be downgraded by a Nationally Recognized Statistical Rating Organization (NRSRO) to below
investment grade status. U.S. government agency securities which are neither issued nor guaranteed by the U.S. Treasury and are not guaranteed against price movements due to changing interest rates. Mortgage-backed securities and asset-backed securities are subject to the risks of prepayment, defaults, changing interest rates and at times, the financial condition of the issuer. Foreign securities carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. Emerging markets securities which are more likely to experience turmoil or rapid changes in market or economic conditions than developed countries.
Performance data quoted represents past performance, which is no guarantee of future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than performance data given. For performance information current to the most recent month-end, visit TouchstoneInvestments.com/mutual-funds.
Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.
Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.
Touchstone is a member of Western & Southern Financial Group
Not FDIC Insured | No Bank Guarantee | May Lose Value
