Opportunities in bonds

Mounting worries about ballooning US deficits have roiled the bond market, sending long-term bond rates to new highs, despite the Fed’s recent cuts in short-term rates. Does that mean investors should be wary of Treasury and other high-quality bonds now?

That could be a mistake, says Robin Foley, Head of Fixed Income at Fidelity. "I believe it to be a good time for bonds, even if some people don't think so," she says.

To be sure, risks exist in bonds, just as they do in any investment. Fidelity's Asset Allocation Research Team agrees that rising government debt has long-term implications for both stock and bond markets. However, there are plenty of reasons to believe that bonds can continue to play a useful role in diversified portfolios in the second half of 2025 and beyond.

If an investor is looking for income from individual bonds, current yields near multi-decade highs in longer-term bonds can offer an opportunity. And if they are considering bond funds or ETFs to diversify their portfolio, Fidelity's bond managers believe that a combination of high current yields and interest rates that are expected to gradually fall later this year is creating an attractive total return opportunity for bond investors in the months ahead.

Michael Plage, a portfolio manager at Fidelity, believes that the second half of 2025 is likely to be a good time for skilled bond investors to take advantage of that potential opportunity.

What's the worry?

The US and most developed market economies have high levels of government debt and some long-term investors have begun to demand higher yields in return for loaning money to these governments for 10 years or longer. Their concern is that higher debt and resulting long-term inflation will reduce the value of the fixed interest payments they receive on those bonds. In response, they have begun to demand what is called a term premium, which is a higher yield on longer-term bonds.

Despite the newfound concern being expressed about the threat of rising debt to bond markets, high government debt is not new, unique to the US, or only a risk to bonds. The surge in concern about how it might eventually affect bonds should not obscure other factors which may matter more for bond investors in the nearer term. These include attractive yields and the likelihood that interest rates will move lower, both of which may give high-quality, low-risk investment-grade bonds the potential to deliver both attractive interest payments and more potential for capital appreciation than stocks or cash in the months ahead.

Reasons to be optimistic

To understand why opportunity exists in bonds in the second half of 2025, it’s important to remember where bond returns come from. A bond can deliver return to its owner from 2 sources: interest payments known as coupons whose rate is set at the time the bond is issued, and changes in the price of the bond as it trades in the market.

The interest rate of the coupon remains the same until the bond matures but the price can rise or fall throughout the trading day. Because bond prices typically rise when interest rates fall, the best way to earn a high total return from a bond or bond fund is to buy it when interest rates are high but coming down. Past performance is no guarantee of future results, but in similar periods historically, investors have been able to lock in still relatively high coupon yields and also enjoy the increase in the market value of their bonds as rates come down and prices rise.

Why bonds may be better than cash in the second half of 2025

Plage believes that bonds in the second half of 2025 present a unique and appealing opportunity for investors who have been sitting in money market funds or short-term CDs to not only lock in longer-term coupon income and seek potential capital appreciation, but also to reduce risk in their portfolios. Yields on CDs and money markets rose to roughly 5% after the Fed began raising short-term interest rates in 2022. But those yields have moved lower following a series of Fed rate cuts late last year and are widely expected to fall further and stay lower than they had been. That raises the risk that investors who need a certain level of income from their portfolios won’t get it if they stay in cash or short-term investments like money market funds and short-term CDs.

Term premium, good or bad?

The return of a term premium to longer-maturity bonds has been one of the more significant forces driving bond markets so far in 2025 and it's likely to remain so through the second half of the year. While the revival of demand by investors for higher long-term yields has helped fuel volatility so far this year, it may also be a sign that the bond market is returning to how it has behaved throughout most of history, where supply and demand, rather than central bank monetary policy, drive the market.

Since the financial crisis, bond yields have been strongly influenced by the policy of the Federal Reserve, which has kept rates low and liquidity abundant through its policy of buying large quantities of US Treasury bonds. As the Fed has stepped back from this policy known as quantitative easing though, market forces that used to play a greater role in determining bond yields and prices are beginning to do so again. The most notable example of this is currently in long maturity US Treasury bonds. While the return of the term premium after its long QE-induced nap has been startling so far this year, the return of a more historically normal bond market may be creating opportunity for some investors in individual longer-term bonds.

Whether the rising term premium is an opportunity or a risk may depend on the amount of money an investor has to invest, their needs for income, and their time horizon. If an investor has several hundred thousand dollars to invest and can hold their bonds to maturity, they may be able to construct a portfolio of high-quality, low-risk bonds with reliable yields that are higher than other fixed income or short-term cash investments.

If an investor wants to invest in bond funds instead of individual bonds, the rising term premium on longer-maturity bonds may mean increased price volatility (which they may not want from their bond portfolio) in bond funds. One way to potentially reduce this risk is by investing in bond funds that own short and intermediate investment-grade debt.

“Short and intermediate bond funds might offer their most compelling storyline since 2008—a potential return advantage, relatively low volatility, and some of the highest starting yields in years,” says Michael Scarsciotti, head of the investment specialists at Fidelity Investments. While past performance is no guarantee of future returns, since 2012, these funds, on average, have generated 88% of the return of longer-term core bonds with 52% less volatility. That’s because shorter-term bonds have shown less sensitivity over time to changes in interest rates.

Bonds as portfolio diversifiers

In the second half of 2025, Fidelity bond managers are also keeping an eye on the relationship between stock prices and bond prices. Bonds and stocks have historically moved in opposite directions, which has meant that bonds have been able to preserve the value of investors' portfolios when stocks have fallen. So far in 2025, bond and stock prices have been more correlated than they have been historically. Institutional Portfolio Manager Beau Coash believes that relationship may normalize in the months ahead as well. “I still believe bonds can help provide portfolio stability and may help mitigate risks during extreme stock market downturns,” he says. "Some investors may look at the recent correlation with stocks and the unexpected Treasury moves and decide that bonds aren’t a reliable source of ballast for their portfolios. But over longer time frames, I’ve noted low correlations between bonds and stocks.”

Investing in a bond mutual fund or ETF

Buying shares of a bond mutual fund or ETF is an easy way to add a bond position. Bond funds hold a wide range of individual bonds, which makes them an efficient way to diversify your holdings even with a small investment.

An actively managed fund also gives you the benefits of professional research. For example, the managers can make decisions about which bonds to buy and sell based on huge volumes of information including bond prices, the credit quality of the companies and governments that issue them, how sensitive they may be to changes in interest rates, and how much interest they pay.

Not all bond funds are actively managed. Investors who seek bond exposure in a fund can also choose among exchange-traded and index funds that seek to track bond market indexes such as the Bloomberg US Aggregate Bond Index.

Here's more about the difference between investing in bond mutual funds or ETFs and individual bonds.

Investing in individual bonds

If an investor has enough money and believes they have the time, skill, and will to build and manage their own portfolio, buying individual bonds may be appealing. Unlike investing in a fund, doing it themselves lets an investor choose specific bonds and hold them until they mature, if they choose. However, an investor still would face the risks that an issuer might default or call the bonds prior to maturity. This approach requires an investor to closely monitor the finances of each issuer whose bonds they're considering. An investor also needs enough money to buy a variety of bonds to help diversify away at least some risk. If an investor is buying individual bonds, Fidelity suggests they consider spreading investment dollars across multiple bond issuers.

Fidelity offers over 100,000 bonds, including US Treasury, corporate, and municipal bonds. Most have mid- to­ high-quality credit ratings that would be appropriate for a core bond portfolio.

Personalized management

Separately managed accounts (SMAs) combine the professional management of a mutual fund with some of the customization opportunities of an investor doing it themselves. In an SMA, an investor invests directly in the individual bonds, but they are managed by professionals who make decisions based on factors such as current market conditions, interest rates, and the financial circumstances of bond issuers.

Whatever an investor's bond investing goals may be, professionally managed mutual funds, active ETFs, or separately managed accounts can help.