The financial world loves a good comeback story, and in 2024, bonds were hailed as the perfect asset for a rate-cutting cycle. Despite fewer cuts than anticipated, the ‘bonds are back’ narrative itself has returned with renewed vigour.
Vanguard seems convinced. Its 2025 outlook boldly states, “Bonds are still back.” State Street Global Advisors echoed this earlier in the year, calling fixed income the “most attractive asset class.” The claim remains popular, even topping searches on the topic. Google’s AI tool Gemini backs it up too, assuring users: “Yes, bonds are back.”
The argument for bonds boils down to one thing: higher yields. Higher starting yields create a “coupon wall”, Vanguard explains, providing a buffer against the impact of modest yield increases on future bond returns. For long-term investors, rising interest rates could enhance total returns over time, even if short-term losses are a possibility.
Hawkish messaging
This is essentially last year’s pitch with yields at comparable levels, just the messaging has grown slightly more hawkish. Even so, it proved effective.
Take Vanguard’s Total International Bond ETF (BNDX). It’s up 4,3 percent this year, but over five years it has delivered 0,16 percent annually. Over a decade, it barely squeaks out 2,8 percent. Pimco’s famed Total Return Fund isn’t much better: 4,4 percent this year but a paltry 0,5 percent over five years, and 1,8 percent over 10 years. Strictly speaking, that’s a comeback.
“We’ve had a decade of negative interest rates. Now initial yields are around 4 to 5 percent. Compared to long-term equity returns of 7 percent, that’s quite appealing for adjusting your asset allocation accordingly—especially given some market valuations,” said Richard Abma, chief investment officer at OHV, whose flagship Fresh Fixed Income Fund has delivered an impressive return of almost 6.3 percent this year.
Which bonds are back?
Many fixed-income cheerleaders point to investment-grade corporate bonds as the sweet spot for 2025. In the US, they offer yields of around 5,25 percent, while European counterparts hover near 3 percent. Credit spreads have tightened to levels not seen since the late 1990s, reflecting strong investor demand.
Chris Iggo, strategist at AXA IM, notes the recent returns demonstrate the potential of this asset class. US investment-grade bonds have delivered an annualised income return of 4.6 percent over the past three months, while high-yield bonds have achieved 6.5 percent. These returns highlight the strength of income generation in corporate credit markets, even as tighter spreads limit further price appreciation.
Quality pays off
Similarly, asset managers such as Vontobel Asset Management and Lombard Odier foresee high-quality bonds delivering returns of 7–8 percent, far above the 2–3 percent yields seen during the low-rate environment of the 2010s.
Richard Abma highlights niche opportunities in the Netherlands, where SME funds yield 4.5 percent with over 80 percent collateral backing. He also points to AAA-rated export financing loans yielding over 3 percent annually with short durations. These are solid alternatives, but they’re hardly a game-changer for global portfolios. And they hinge on the Netherlands’ strong payment discipline, a strength that doesn’t necessarily translate to other markets.
Investors remain cautious
Despite the optimistic outlook, scepticism lingers. A survey by Managing Partners Group found that 57 percent of institutional investors and wealth managers allocate less to fixed income than their benchmarks. Only 17 percent have raised their exposure above benchmark levels.
The Federal Reserve was widely expected to cut rates multiple times in 2024—at one point, seven cuts were priced in. However, with inflation proving more persistent than anticipated and the US economy defying slowdown predictions, those rate cuts have been slow to materialise. As of early December, the Fed has delivered only two cuts this year, lowering benchmark rates by a mere 0,75 percent.
The broader economy has resisted the narrative of a downturn. Far from sliding into recession, developed economies have shown surprising resilience, driven by factors such as rising labour productivity and workforce growth. These dynamics have kept inflation above target levels, forcing both the Federal Reserve and the European Central Bank to tread cautiously on monetary easing.
Even Vanguard cautions about potential headwinds, including fiscal deficits, rising inflation expectations, and geopolitical tensions, all of which could weigh on bond performance. If this is a bond comeback, it’s one written in pencil, not ink.
Resilient economies challenge narrative
Contrary to expectations of a downturn, developed economies have displayed remarkable resilience, supported by rising labour productivity and workforce growth. These dynamics have kept inflation above target levels, prompting caution from both the Federal Reserve and the European Central Bank.
Even Vanguard warns of looming risks, including fiscal deficits, rising inflation expectations, and geopolitical tensions, all of which could weigh on bond performance. If this is a bond comeback, it’s one written in pencil, not ink.