Conventional wisdom and widespread assumptions sometimes don’t always play out. For fixed-income investors, this is happening in real time. With the Federal Reserve (Fed) cutting interest rates amid already-high starting yields, what should be a great period for bonds is turning into a nightmare. The Fed is cutting, but bond prices are falling, pushing up yields.
The worst part is that this may continue for some time.
Many analysts are predicting that benchmark Treasuries could hit 5% — or even 6% — yields before the year is out. Trends are in place to help make these forecasts come to fruition. Fixed-income investors certainly have some things to consider for their portfolios in the near term.
Losses Oo Fixed Income
Many fixed-income and bond investors are scratching their heads. After all, this year was supposed to be the year of the IOU. Inflation was beaten, and the Fed kicked off its regime of rate cuts.
This should have produced some very juicy total returns for bonds. Yields are already high after the bond rout of 2022/2023, and the cutting of interest rates should have lifted bond prices. This would have created a bullish bond environment and produced enviable total returns.
Except that hasn’t happened. More recently, bonds have started to tank in a big way and have moved in the opposite of expectations. The Bloomberg US Aggregate Bond Index — the bond market’s benchmark—had a positive return of 1.37% last year. Taking away coupon payments, the index lost money.
Those losses have only gotten worse since the start of the new year. The yield on the 10-year Treasury—the standard bearer for bonds—has gained roughly four basis points since the start of 2025 to reach 4.73%, the highest level since November 2023. Other bond yields also have been climbing. The 30-year yield has now hit 4.96%, while the 20-year—reintroduced back in 2020—has already hit 5%.
This chart from Bloomberg highlights the sharp increases in long bonds in recent weeks.
Source: Bloomberg
Worrisome Trends
The question is, why? Why have bonds started to reverse course amid an excellent environment of rate cutting and already high yields? The answer is complex, but it has to do with inflation, rising debt loads, and uncertainty about future policy.
We are now in a “good news is bad news” situation. The economy is still moving along just fine, prompting the Federal Reserve to begin its rate-cutting scheme. However, no good deeds go unpunished. And with the Fed starting to cut rates, the economy may be moving too fast once again. Inflation has quickly started to move higher since October.
That puts the Fed between a rock and a hard place. The economy is growing, albeit at a slow pace. So, if it raises rates to combat inflation or pauses as predicted, it could slip the economy into a recession and avoid the soft landing it’s working hard to maintain. Bond investors are already predicting that higher long-term rates will be here to stay. And some FedWatch tools have even begun to factor in a slight chance of the Fed being forced to raise rates. Investors are already demanding more yield today for their bonds for that scenario.
Secondly, the election of incoming President Trump is expected to boost the economy further, but at a potential cost. Trump’s tariff policies have the potential to limit growth and ignite inflation further. At the same time, tax proposals are expected to increase the Federal deficit by about $7.8 trillion over the next decade, according to the nonpartisan Committee for a Responsible Federal Budget.
So-called bond vigilantes have stepped in and are now worried about federal fiscal health and have started to demand more from the Treasury to compensate for these growing risks. The result is that bond yields have started to creep higher.
Many analysts — from ING and Mizuho to Goldman Sachs and T. Rowe Price — now predict that the yield on the 10-year Treasury will hit 5%, or even 6%, before the year is out. Many of the trends in place today don’t seem to have an orderly end. They may get worse before they get better.
Positives & Negatives for Bond Investors
Rising yields and growing risks certainly do not make for smooth sailing for bond investors or those looking to add fixed-income assets to their portfolios. Perhaps the only comfort is that equity investors may have it worse as higher yields reduce equity returns.
The question is how to play all of this.
Going short, as in short-term bonds, could make sense. Bonds with near-term maturities— such as those between one year and 3.5 years—aren’t nearly as volatile as those with longer timelines. Because of their shorter timelines, short-term bonds have lower durations and can “roll over” faster than a 30-year bond. The result is they are less volatile to rate changes and sell-offs. The Fed’s slowdown of rate cuts has left many short-term bonds with still attractive yields.
Another choice? Buy the 5% yields. For investors, locking in 5% or 6% yields could be attractive ways to gain income in the years ahead. Now, there is some risk that prices could decline further. But the near-term volatility may seem like a moot point if you buy individual bonds, which is easy to do with Treasuries and holding till maturity or a much later date. After all, you get your principal back once the bond matures. This could seem like a really attractive play.
Moreover, those 5% yields could seem attractive if the economy moves into recession. The safety of bonds—especially at such a high yield—would push prices up and increase the potential to register capital gain.
Short-Term Bond ETFs
These ETFs are selected based on their ability to tap into short-term duration bonds at a low cost. They are sorted by their one-year total return, which ranges from 3.3% to 4.8%. Their expense ratio ranges from 0.03% to 0.56% and they yield between 3% and 5.1%. They have AUM between $730M and $58B.
| Ticker | Name | AUM | 1-year Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| DFSD | Dimensional Short-Duration Fixed Income ETF | $1.55B | 4.8% | 3.9% | 0.18% | ETF | Yes |
| FSIG | First Trust Limited Duration Investment Grade Corporate ETF | $731M | 4.8% | 4.6% | 0.56% | ETF | Yes |
| SPSB | SPDR Portfolio Short Term Corporate Bond ETF | $7.3B | 4.6% | 5.1% | 0.04% | ETF | No |
| LDUR | PIMCO Enhanced Low Duration Active ETF | $989M | 4.5% | 4.7% | 0.51% | ETF | Yes |
| SHY | iShares 1-3 Year Treasury Bond ETF | $26B | 3.4% | 3.8% | 0.15% | ETF | No |
| SCHO | Schwab Short-Term U.S. Treasury ETF | $12.4B | 3.5% | 3.9% | 0.03% | ETF | No |
| BSV | Vanguard Short-Term Bond ETF | $58B | 3.3% | 3% | 0.04% | ETF | No |
All in all, investors are realizing that bonds could see higher yields in the new year. Driven by various market forces and factors, the yield curve is quickly becoming parabolic. That’s an interesting environment for investors to operate in. Going short could help limit the effects of price decreases. But if an investor is confident they can hold a longer maturing bond for the entire time or perhaps many years, those 5% to 6% potential yields on the 10-, 20- and 30-year bonds could be bought to boost their income.
Bottom Line
Despite the Fed cutting rates, bond yields are rising, and prices are declining. This has led to barely positive returns last year. Now, with many trends persisting, bond yields could approach 5% or more in 2025. For investors, that means buying them outright for higher income or going short to protect themselves.
