Bonds to rise in 2025, on pace for best year since 2020 bond rally

Almost everything is lining up for bonds lately.

The Federal Reserve has lowered interest rates. Job growth and consumer spending are slowing, keeping hopes alive for further cuts, but this does not signal an impending recession that would threaten corporate balance sheets. Inflationary pressures have continued to ease despite fears that President Trump’s tariffs will push up prices.

The widely followed Bloomberg US Aggregate Bond Index has a return of about 6.7% through 2025, which takes into account price changes and interest payments. This puts the stock on track for the best year since 2020.

Bonds had regained ground after the Fed’s anti-inflation campaign fueled a historically bad 2022. The Bloomberg Agg – largely made up of government bonds, investment-grade corporate bonds and government agency mortgage-backed securities – returned 5.5% in 2023, although it came to a near standstill in 2024.

Investors said 2025 feels different. The rise has rewarded investors still reeling from the unusual volatility that followed the Covid-19 era inflation wave. Unlike in previous years, the index’s returns have comfortably exceeded those of short-term government bonds – the other main choice for investors looking for a safe alternative to shares.

“It’s definitely been more fun going to client meetings as a bond manager this year,” said Cal Spranger, fixed income manager at Badgley Phelps Wealth Managers. “A few years ago I wasn’t invited to anything.”

Although government and corporate bond yields have gradually fallen, they are still well above the meager levels of the past decade – and investors want to hold on to them while they can.

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Earlier this year, short but sharp sales of U.S. Treasury bonds raised alarms that the bond market might finally buckle under the pressure of excessive U.S. borrowing. The size of the budget deficit can affect yields because a larger deficit means the government must borrow more by issuing government bonds, and in turn attract demand for those debts with higher interest rates.

Falling interest rates have largely overcome these concerns because bonds issued when interest rates are high become more valuable when they are expected to fall. At the start of the year, investors were unsure whether the Fed would be able to cut rates given persistent inflation and expectations that Trump would pursue an expansionary fiscal policy. But a cooling labor market has already led to two cuts this year, and another cut is still possible.

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As a result, government bond yields, which fall when bond prices rise, have fallen. The yield on the 10-year bond has fallen by almost half a percentage point this year, reaching 4.147% on Friday.

U.S. Treasury Secretary Scott Bessent and U.S. President Donald Trump look on during the White House Digital Assets Summit in the State Dining Room of the White House on March 7, 2025 in Washington, DC. (Anna Moneymaker/Getty Images/Getty Images)

Bonds also help: The Trump administration has kept a close eye on the market, sometimes taking action during turbulent periods. The president suspended most of his so-called mutual rates in April because of “yippee” bond investors. Finance Minister Scott Bessent has said keeping yields on longer-dated government bonds low was a priority for the government. They act as a benchmark for financing costs for everything from mortgages to student loans.

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There are still many threats to the rally. The path for rate cuts has been clouded by a split among central bank officials, with some throwing cold water on the likelihood of a rate cut in December. Federal Reserve Chairman Jerome Powell warned in October that the Fed is “a long way from” deciding to cut rates next month, an unusually blunt comment from a central banker.

Investors now believe that a rate cut in December is roughly a coin flip. The futures markets had priced in about a 46% chance of a cut on Friday, according to the futures markets CME Group data, down from about 67% a week earlier.

Some worry that the U.S. credit market is overheated and that historically high corporate bond valuations are masking market excesses and not sufficiently compensating investors for taking risks. The additional return, or spread, that investors receive for holding investment-grade corporate bonds over government bonds fell to 0.72 percentage points in September, the lowest level since the late 1990s. Since then, interest rates have risen modestly to 0.83 percentage points.

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Some analysts warn that the US government’s budget deficit is likely to weigh on the bond market again. The deficit for the 2025 budget year was $1.8 trillion, virtually unchanged from 2024.

“It’s definitely going to be a problem at some point,” said Mike Goosay, chief investment officer and global head of fixed income at Principal Asset Management. “You can only borrow so much before investors start moving away from you.”

Many see the good times continuing and believe interest rates should fall even further, despite the recent increase in uncertainty.

Matt Brill, senior portfolio manager and head of North American investment-grade credits at Invesco, said his team favors short-term bonds as he believes coming economic data will prompt the Fed to continue cutting spending.

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“There aren’t many layoffs, but there aren’t many jobs created,” he said. “I think the Fed is looking at that, and it concerns them.”

Write to Krystal Hur at krystal.hur@wsj.com and Sam Goldfarb at sam.goldfarb@wsj.com