Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 623

Things may finally be turning for the bond market

The Reserve Bank of Australia surprised markets by holding the official cash rate steady at 3.85% last month, marking its third consecutive pause despite growing expectations of an easing cycle.

With inflation now tracking comfortably within the RBA’s target band and consumer confidence weakening, many market participants had priced in a rate cut. The RBA’s decision, therefore, reinforced a broader theme playing out in global markets: central banks are proceeding cautiously.

Bonds are in better stead

After a relatively volatile period in fixed income markets, albeit one where returns from global bonds have been strong, especially credit, global bonds are entering the second half of 2025 in a stronger position. Amid an environment of softening global growth, evolving inflation dynamics, and heightened geopolitical and policy risks, global bond markets appear poised to deliver compelling income and relative stability.

US economic activity is moderating, with consumer spending and labour market strength slowly easing. This softening, combined with persistent uncertainty over tariffs, immigration policy, and geopolitics, has many investors reconsidering their portfolio allocations. In this setting, bonds are regaining their status as a core diversifier and income engine.

For bond portfolios, balancing return potential with downside protection is key. Many investors are tilting toward higher-quality credit across sectors and issuers, as the current market environment does not sufficiently reward taking on excessive credit risk.

Despite the recent pause by the US Federal Reserve, rate cuts remain possible. As of June 2025, the Fed kept its target range at 4.25% to 4.50%, but market expectations suggest modest easing by year-end. If growth data disappoints, intermediate-duration bonds could benefit meaningfully.

The steepening of the US yield curve has also drawn attention. While shorter-term yields have eased, the 10-year Treasury yield climbed to 4.39% in June. This signals the market’s acceptance of a higher long-term cost of capital and some lingering inflation concerns—but it also provides a more attractive income base for long-term investors.

As equities entered a correction, bonds provided a buffer

Past results are not a guarantee of future results. Source: Bloomberg. As of 8 April 2025. A correction is defined as a price decline of 10% or more (without dividends reinvested) in the S&P 500 Index with at least 75% recovery.

One of the most promising developments is the re-emergence of the negative equity-bond correlation. Earlier this year, as the S&P 500 corrected by nearly 19% from its February peak to its April low, the Bloomberg US Aggregate Bond Index rose 1%. That traditional diversifying behaviour is particularly valuable in a period marked by policy and market unpredictability.

Globally, policy divergence is creating select opportunities. In Europe, Germany’s fiscal expansion and the stronger euro are helping suppress inflation, giving the ECB more scope to cut rates. In Japan, yield curve steepening caused by bond market dislocation may trigger a pause in further Bank of Japan tightening as they respond to supply-demand imbalances.

Within securitised markets, mortgage-backed securities (MBS) offer attractive risk-adjusted returns. Higher-coupon agency MBS provide competitive yields with lower duration risk. Their liquidity and resilience in past downturns make them particularly appealing in today’s environment. Value can also be found in certain subprime auto and commercial mortgage-backed securities that offer strong structural protections and income potential.

Corporate bond markets are holding up well. Investment-grade issuers continue to improve credit quality by reducing debt, and many high-yield companies have stable cash flows and reduced refinancing risk. In today’s market, yields between 4% and 8% across quality credit segments offer a strong starting point for long-term returns. Even if spreads widen, the elevated income helps cushion total returns.

High-yield bonds posted strong returns at current yields

Sources: Bloomberg Index Services Ltd. As of 31 May 2025. Average forward two-year and three-year returns are annualized.

Emerging markets are also worth watching closely. Declining energy prices, easing inflation, and weaker global growth have many EM central banks shifting toward looser policy. A reduced reliance on foreign capital, in favour of more stable domestic investor bases, makes these markets less prone to the shocks experienced in prior risk-off episodes.

The macro backdrop continues to favour bonds. Higher starting yields, better diversification properties, and potential for price appreciation if central banks ease more quickly than expected make a strong case for global fixed income.

This is the kind of environment where active management matters—navigating regional dispersion, credit selection, and curve positioning will be critical to capturing value while managing risk.

With all of these dynamics at play, the second half of 2025 may represent an ideal time to re-engage with global bonds—not as a defensive afterthought, but as a core source of durable income and strategic value.

 

Haran Karunakaran is an Investment Director at Capital Group (Australia), a sponsor of Firstlinks. This article contains general information only and does not consider the circumstances of any investor. Please seek financial advice before acting on any investment as market circumstances can change.

For more articles and papers from Capital Group, click here.

 

  •   6 August 2025
  • 3
  •      
  •   

RELATED ARTICLES

Why we believe bonds are now beautiful

What does the current yield curve tell us?

The RBA's balancing act

banner

Most viewed in recent weeks

Are you making these SMSF mistakes?

After four decades advising investors, there are a few common mistakes I've seen SMSF investors make. From holding too much cash and chasing yield to overtrading and trusting tips. Are these errors costing you?

Why have Australian living standards 'fallen' and how do we fix it?

For the last few years there has been much talk of a 'cost-of-living' crisis in Australia and of 'falling living standards'. Lately this has flared up again with the pickup in inflation resulting in a renewed fall in real wages.

Will you run out of money in retirement?

Fear of running out has become a defining retirement anxiety. Why do some retirees die with substantial wealth while others deplete their nest egg? Evidence suggests the answer is more complicated than we think. 

Retirement spending is not one-size-fits-all

New data challenges the idea that Australians are underspending their super. The bigger issue may be helping retirees navigate complexity, make confident decisions and use their savings to support security, wellbeing and choice.

Four options for an income investor’s next dollar

What if Australia’s golden age of dividends is ending? Rather than overhaul your portfolio, it may be worth considering where new capital can work harder. I discuss four income strategies and the trade-offs behind each.

The missing link in the CGT debate

A little-noticed consequence of Labor’s tax changes could have implications well beyond investors’ tax bills. The issue raises bigger questions about incentives, capital allocation and the drivers of long-term economic growth.

Latest Updates

SMSF strategies

Meg on SMSFs: What do we think about reversionary pensions these days?

Reversionary pensions have long been a staple of SMSF estate planning, but are they still the best option? Meg Heffron revisits a once-clear favourite and asks whether changing super rules have shifted the balance.

The ageing ‘crisis’ has not and will not happen

Rising age dependency is frequently treated as a warning sign for economies. But when actual workforce participation is examined, a strikingly different picture emerges about ageing, productivity and economic sustainability.

Retirement

How does the 4% rule stack up?

The 4% rule has long been retirement's gold standard. But after a difficult period for investors, fresh analysis suggests a more conservative approach may significantly improve the chances of making savings last.

Shares

Four charts that expose market concentration risk

Investors have recently been rewarded for backing market leaders, but history suggests this eventually comes at a cost. Now may be the time to review whether your portfolio is carrying unintended risks beneath the surface.

Investment strategies

The case for gearing beyond property

Most Australians gear into property but ignore shares. That may be a mistake. Used carefully, geared equity strategies can enhance long-term returns, reduce cash tied up in growth assets and support retirement income goals.

Economy

Australia's $1 trillion debt pile

The headlines exclaiming that Australian government debt has hit A$1 trillion and US government debt has hit $40 trillion has turned heads, but how serious are they really? Will Australia's mix of debt create challenges?

Economy

Has 100 years of growth made us any happier?

For decades, GDP has been the benchmark for economic success, but has it made us materially happier? If happiness does not rise in lockstep with prosperity, are we overlooking what constitutes a successful society?

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.