If there has been one driving fixed-income story over the last few years, it has been the Federal Reserve and its interest rate policy. After raising rates to levels not seen in decades to combat equally high inflation, the central bank has remained still, alternating between hawkish and dovish stances. Many pundits and investors have taken the uncertainty in stride, waiting for the day the Fed begins cutting in earnest.
Those cuts may finally be at hand.
For fixed-income seekers, this could be the moment we have all been waiting for. With the Fed shifting course, bonds could be off to the races and put up some of their best performances in years. The best part is that there is still ample runway left.
Policy Direction
Investors hate uncertainty, especially conservative fixed-income investors. That is why the last few years have been so hard to navigate. We all know the Fed raised rates to combat inflation. After inflation was basically whipped, at least from its highs, the central bank cut rates, but then paused rate cuts, setting forth ample confusion.
Thanks to stubborn inflation, a mixed economy, and other factors, the Fed kept rates steady for nearly a year, leaving investors in a quandary. At every Federal Open Market Committee (FOMC) meeting, the question was, “Will they cut or keep rates the same?” and the results seemed like a coin flip. Data presented an assorted picture, while statements from Jerome Powell threw ample contradiction into the works.
But now, we may finally have clarity on the direction of rates. The government shutdown and souring labor market have forced the Fed’s hand to cut rates.
Following a 0.25% cut in September, the Fed cut again by 0.25% in October, bringing the federal funds target rate into a range of 3.75% to 4.00%. Moreover, the continued mix of data and potential for economic slowdown now has analysts and Fed members projecting another cut in December of this year and three more in 2026. 2
This chart from U.S. Bank highlights where the markets see interest rates heading over the next few years.
Source: U.S. Bank Wealth Management
A Boon For Bonds
With these lower rates and a new policy regimen, bonds could be the biggest winners, as bonds and interest rates have an inverse relationship.
As the Fed starts to cut rates, new bonds coming to market will yield less, reflecting the changes in interest rate policy. However, bonds already issued and on the market continue to yield high amounts, making them desirable for investors. As such, their prices would rise to match new, lower-yielding bonds hitting the streets. This allows investors to see capital gains on their bonds if they purchase them before the Fed starts cutting rates. The key thing to note is that the greater a bond’s duration—its sensitivity to changes in interest rates—the higher its potential return.
What’s more is that the current high-interest-rate environment reset yields for many fixed-income asset classes. Today, investors can score current yields of 4%+ across a variety of bonds. This high starting yield is a significant selling point when it comes to a high starting return. Remember, you’re locking in that yield when you buy a bond till it matures. This yield, plus the potential for capital appreciation, is why bonds could give the edge over the next few years.
The proof is in the pudding.
Looking at the Bloomberg U.S. Aggregate Index since the 1990s and the different periods of rate cuts, the bond benchmark returned between 16% and 31% over the next two years. Similarly, the Bloomberg U.S. Corporate Investment Grade Index produced returns between 21% and 32%. Those returns were a mix of capital gains and initial starting yields. A return to more normal interest rates, plus today’s high starting yield, would allow bonds to be at the higher end of the range, if historical data is enough to go on. 1
With the Fed now starting to cut rates, this scenario can play out, helping bonds produce some of the best returns in years.
Betting On The Bond Winning Streak
Now that the Fed has started its rate-cutting path, there’s not much time to lose when it comes to bonds. The cycle of higher prices and lower yields has begun. To that end, it makes sense to add bonds to a portfolio.
Bond funds are uniquely positioned to benefit from this environment because their mandates make them roll over bonds continuously. During falling rate environments, this leads to higher share prices. Focusing on credit and sectors outside treasury bonds could also prove advantageous, with additional yield potential.
Popular Bond Exchange Traded Funds (ETFs)
These ETFs were selected based on their ability to provide access to investment-grade bonds at a low cost. They are sorted by their year-to-date (YTD) total return, which ranges from -3.4% to 1.4%. They have assets under management of $3.77 billion to $316 billion and expenses of 0.03% to 0.40%. They are currently yielding between 2.9% and 7.6%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| SJNK | SPDR Bloomberg Short Term High Yield Bond ETF | $3.77B | 1.4% | 7.6% | 0.40% | ETF | No |
| USHY | iShares Broad USD High Yield Corporate Bond ETF | $8.99B | 1.3% | 7.2% | 0.08% | ETF | No |
| VCSH | Vanguard Short-Term Corporate Bond Index Fund | $42.6B | 0.4% | 3.6% | 0.04% | ETF | No |
| BSV | Vanguard Short-Term Bond Index Fund | $58.8B | 0.1% | 2.9% | 0.04% | ETF | No |
| SHY | iShares 1-3 Year Treasury Bond ETF | $26.3B | 0.1% | 3.5% | 0.15% | ETF | No |
| VCIT | Vanguard Intermediate-Term Corporate Bond Index Fund | $39.6B | -0.2% | 4.1% | 0.04% | ETF | No |
| BND | Vanguard Total Bond Market Index Fund | $316B | -0.4% | 3.3% | 0.03% | ETF | No |
| AGG | iShares Core U.S. Aggregate Bond ETF | $90.4B | -0.8% | 3.5% | 0.03% | ETF | No |
| LQD | iShares iBoxx $ Investment Grade Corporate Bond ETF | $27.9B | -1.1% | 4.3% | 0.14% | ETF | No |
| TLT | iShares 20+ Year Treasury Bond ETF | $49.8B | -3.4% | 3.7% | 0.15% | ETF | No |
All in all, with the Fed now beginning its rate-cutting scheme, bonds could finally have their time in the sun. Ultimately, strong current yields plus high bond prices will be a significant win for portfolios, and now, we have that concept in motion. For investors, buying fixed-income assets for a portfolio makes sense.
Bottom Line
After what seems like months of waiting, the buy signal for bonds is here. Fixed-income investors can anticipate stronger returns now that the Federal Reserve has begun reducing interest rates.
1 Insight Investment (2024-02). The fixed income party is just getting started
2 U.S. Bank (2025-10). How changing interest rates impact the bond market
