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.

 

RELATED ARTICLES

Why we believe bonds are now beautiful

What does the current yield curve tell us?

Duration: Friend or foe in a defensive allocation?

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Retirement

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

Shares

Boom, bubble or alarm?

After a stellar 2025 to date for equities, warning signs - from speculative froth to stretched valuations - suggest the market’s calm may be masking deeper fragilities. Strategic rebalancing feels increasingly timely.

Property

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Economy

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Shares

Is the iPhone nearing its Blackberry moment?

Blackberry clung on to the superiority of keyboards at the beginning of the touchscreen era and paid the ultimate price. Could the rise of agentic AI and a new generation of hardware do something similar to Apple?

Fixed interest

Things may finally be turning for the bond market

The bond market is quietly regaining strength. As rate cuts loom and economic growth moderates, high-quality credit and global fixed income present renewed opportunities for investors seeking income and stability. 

Shares

The wisdom of buying absurdly expensive stocks (or not!)

Companies trading at over 10x revenue now account for over 20% of the MSCI World index, levels not seen since the dotcom bubble. Can these shares create lasting value, or are they destined to unravel?

Sponsors

Alliances

© 2025 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.