What’s driving bonds and where might they be headed?

With geopolitical uncertainties influencing credit markets, we discuss the various market drivers and where we think bonds may be headed in the coming months.

Craig: There’s been a lot of speculation about a buyer’s strike on US Treasuries, bonds, and equities. What’s your take?

Matt: We're not seeing a buyer strike, or even a buyer's pause. We're just seeing a little bit more competition. Yields are higher in a lot of different places, particularly in Japan, so they’re competing with US assets. That’s opposed to the last several years where they were the only game in town because of negative yielding debt around the globe. Also, there are some tax policies in the Trump administration’s “Big Beautiful Bill” that have the potential to deter foreigner investors. Also, there was an initial shock from tariffs and concern around volatility. There’s still uncertainty, but the market got a better feel for where Trump may be headed, and overall there's still a huge demand for US Treasurys and fixed income.²

Craig: What's your thinking about the US Federal Reserve (Fed) cutting rates?

Matt: The market is still pricing in two cuts, but I think the feeling has increasingly been that we might not see any cuts this year. We’ve seen better-than-expected labor market statistics and investors are still concerned about inflation given the given the tariff uncertainty. If the Fed doesn’t cut rates this year, it generally will mean that the US economy has been better than people have been fearing. That's starting to look like it might be a possibility. On the other hand, if we were to go into a recession near term, the Fed could quickly cut three or four times to kick start the economy. Overall, our opinion is that the economy is actually better than people had feared. We’ve now had three recessions predicted in just the last three years, and zero of them have played out.

Craig: What are your thoughts about positioning on the yield curve?

Matt: We had a curve steepening, which means we were long on the front end of the curve while being short on the long end of the curve.³ That helped performance. I think it makes sense to still be slightly overweight in the front end based on where we are now. As I said, we do think the economy is better than most people fear. However, if we are wrong and there is a recession, we have an overweight in credit assets. Credit spreads would widen in that scenario, but the curve positioning could somewhat offset that move if the Fed reduced rates. At the same time, we are cautious at the long end because the budget deficit is not going to get any better anytime soon.

Craig: What are your thoughts about bond returns for the rest of the year?

Matt: Annualized returns for fixed income since Q4, 2024 have been around 5.5-6%.⁴ But it hasn't felt good, in our view, because there are concerns around the budget deficit, inflation, and whether the Fed will cut or not. It's been volatile and there’s been a lot of uncertainty.

But you still have attractive yields and that’s what matters most. The yield on the Bloomberg US Corporate Bond Index coming into the year was 5.3%. I think the yield on the Bloomberg US Aggregate Bond Index was about 4.9%. Those are the highest they've been in over 15 years.⁵ So a good way to think about bonds in our view is that you've gotten a better than expected return this year and your yield is still good, so you haven't missed the trade.

Craig: Is the market being too optimistic from a credit spread perspective? How do you think about the next leg of the corporate bond universe?

Matt: It's certainly an unloved bond market right now from a credit standpoint, in our view. I think a lot of investors wish there was more of a credit spread because there’s still uncertainty. However, yields are what's driving inflows, and it’s driving buyers to say “I can buy a high quality single A credit for 10 years at 5.5%. Why would I not want to do that?” We wish spreads were wider, even at their worst, we’re looking at them and saying, “well, they're not pricing in a recession. What happens if it occurs?” Overall, we believe the worst is behind us from a volatility standpoint, which generally means spreads should have a room to run from here.