Expert insight
A terrific environment for bonds
September 02, 2025
In a recent Morningstar article, Sara Devereux, Vanguard’s global head of fixed income, says bond investors are enjoying a rare sweet spot in today’s market. With yields well above pre-pandemic lows and the Federal Reserve expected to begin cutting interest rates soon, the environment remains attractive for long-term investors looking to stabilize portfolios and generate steady returns.
Key insights
- Attractive yields are likely to persist: Even as the Fed prepares to lower rates, bond yields are expected to remain well above the rock-bottom levels seen in previous years.
- Income can act as a cushion: Higher yields offer portfolios a buffer against potential price declines. If the economy weakens and bond prices rally, investors can benefit from price appreciation. If prices fall, bonds’ income component helps absorb the impact.
- Investors should focus on the “belly” of the yield curve: Bonds with maturities of around 5 to 6 years strike a smart balance between income and interest rate risk. This middle ground offers attractive yields without the volatility of longer-term bonds. (For municipal bonds, the sweet spot might extend further.)
- Municipal bonds and investment-grade credit stand out: Devereux highlights municipal bonds for their quality and value, and investment-grade credit for its appealing yields and opportunities for active managers to find value.
- Discipline is key: Investors are encouraged to revisit their fixed income allocations with a long-term lens, and to avoid the temptation to chase headlines or make short-term trades. Bonds should be viewed as a strategic stabilizer for diversified portfolios.
Risks to watch
- Fiscal policy pressures: The growing federal deficit poses a long-term risk to bond markets. While current yields reflect this risk, further deterioration to the fiscal outlook could increase volatility and raise term premiums.
- Tight credit spreads: Riskier bonds aren’t offering much more yield than safer ones, so investors should avoid overstretching for extra return. Active management and careful security selection can be helpful in this environment.
Opportunities ahead
As we approach 2026, policy shifts such as tax cuts and deregulation may provide additional support for both the economy and bond markets. These changes could reinforce the case for fixed income as a strategic allocation. Investors who are underallocated to bonds should consider increasing their exposure, starting with indexing and exploring active management for further opportunities.
Notes:
All investing is subject to risk, including possible loss of principal.
Diversification does not ensure a profit or protect against a loss.
Investments in bonds are subject to interest rate, credit, and inflation risk.
Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund's trading or through your own redemption of shares. For some investors, a portion of the fund's income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.