- In a recent Morningstar interview, Sara Devereux, global head of fixed income at Vanguard, explains why bond investors are benefitting from a combination of attractive yields and expectations of interest rate cuts in the coming months.
- Investors may want to consider the middle—or “belly”—of the yield curve, which strikes a balance between income and interest rate risk, says Devereux.
- Investment-grade credit stands out for its appealing yields and opportunities for active managers to find value.
"The income component of bond returns is a huge tailwind today, so keep clipping that coupon."
Vanguard Global Head of Fixed Income
In a recent Morningstar article, Sara Devereux, Vanguard’s global head of fixed income, says bond investors are enjoying a rare sweet spot in today’s market. With yields well above pre-pandemic lows and the US Federal Reserve (Fed) and other central banks considering further cuts to interest rates, the environment remains attractive for long-term investors looking to stabilise portfolios and generate steady returns.
Key insights
- Attractive yields are likely to persist: Even if the Fed considers further rate cuts in the coming months, US bond yields are expected to remain well above the rock-bottom levels seen in previous years.
- Income can act as a cushion: Higher yields offer portfolios a buffer against potential price declines. If the economy weakens and bond prices rally, investors can benefit from price appreciation. If prices fall, bonds’ income component helps absorb the impact.
- Investors should focus on the “belly” of the yield curve: Bonds with maturities of around 5 to 6 years strike a smart balance between income and interest rate risk. This middle ground offers attractive yields without the volatility of longer-term bonds.
- Investment-grade credit stands out: Devereux highlights investment-grade credit for its appealing yields and opportunities for active managers to find value.
- Discipline is key: Investors are encouraged to revisit their fixed income allocations with a long-term lens, and to avoid the temptation to chase headlines or make short-term trades. Bonds should be viewed as a strategic stabiliser for diversified portfolios.
Risks to watch
- Fiscal policy pressures: Growing fiscal deficits pose a long-term risk to bond markets. While current yields reflect this risk, further deterioration to the fiscal outlook could increase volatility and raise term premiums.
- Tight credit spreads: Riskier bonds aren’t offering much more yield than safer ones, so investors should avoid overstretching for extra return. Active management and careful security selection can be helpful in this environment.
Opportunities ahead
As we approach 2026, policy shifts in the US such as tax cuts and deregulation may provide additional support for both the economy and bond markets. These changes could reinforce the case for fixed income more broadly as a strategic allocation. Investors who are underallocated to bonds should consider increasing their exposure, starting with indexing and exploring active management for further opportunities.
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