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

Building a lazy ETF portfolio in 2026

What are the best ways to build a simple portfolio from scratch? I’ve addressed this issue before but think it’s worth revisiting given markets and the world have since changed, throwing up new challenges and things to consider.

Get set for a bumpy 2026

At this time last year, I forecast that 2025 would likely be a positive year given strong economic prospects and disinflation. The outlook for this year is less clear cut and here is what investors should do.

Meg on SMSFs: First glimpse of revised Division 296 tax

Treasury has released draft legislation for a new version of the controversial $3 million super tax. It's a significant improvement on the original proposal but there are some stings in the tail.

Ray Dalio on 2025’s real story, Trump, and what’s next

The renowned investor says 2025’s real story wasn’t AI or US stocks but the shift away from American assets and a collapse in the value of money. And he outlines how to best position portfolios for what’s ahead.

10 fearless forecasts for 2026

The predictions include dividends will outstrip growth as a source of Australian equity returns, US market performance will be underwhelming, while US government bonds will beat gold.

13 million spare bedrooms: Rethinking Australia’s housing shortfall

We don’t have a housing shortage; we have housing misallocation. This explores why so many bedrooms go unused, what’s been tried before, and five things to unlock housing capacity – no new building required.

Latest Updates

3 ways to fix Australia’s affordability crisis

Our cost-of-living pressures go beyond the RBA: surging house prices, excessive migration, and expanding government programs, including the NDIS, are fuelling inflation, demanding bold, structural solutions.

Superannuation

The Division 296 tax is still a quasi-wealth tax

The latest draft legislation may be an improvement but it still has the whiff of a wealth tax about it. The question remains whether a golden opportunity for simpler and fairer super tax reform has been missed.

Superannuation

Is it really ‘your’ super fund?

Your super isn’t a bank account you own; it’s a trust you merely benefit from. So why would the Division 296 tax you personally on assets, income and gains you legally don’t own?

Shares

Inflation is the biggest destroyer of wealth

Inflation consistently undermines wealth, even in low-inflation environments. Whether or not it returns to target, investors must protect portfolios from its compounding impact on future living standards.

Shares

Picking the next sector winner

Global equity markets have experienced stellar returns in 2024 and 2025 led, in large part, by the boom in AI. Which sector could be the next star in global markets? This names three future winners.

Infrastructure

What investors should expect when investing in infrastructure: yield

The case for listed infrastructure is built on stable earnings and cash flows, which have sustained 4% dividend yields across cycles and supported consistent, inflation-linked long-term returns.

Investment strategies

Valuing AI: Extreme bubble, new golden era, or both

The US stock market sits in prolonged bubble territory, driven by AI enthusiasm. History suggests eventual mean reversion, reminding investors to weigh potential risks against current market optimism.

Sponsors

Alliances

© 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.