U.S. taxable investment-grade bonds advanced 1.10% in the fourth quarter of 2025, as measured by the Bloomberg U.S. Aggregate Bond Index. This result capped a year of elevated volatility, yet one in which the bond market posted gains in all four quarters. For the full year, the Aggregate index rose 7.30%, its best annual result since 2020.

Quarterly performance was fueled by a combination of elevated starting yields and price appreciation, as bond prices rose amid falling interest rates and investor demand, supported by stable fundamentals. The U.S. Federal Reserve, after resuming the monetary easing program it had paused from January until September of this year, followed through with additional policy rate reductions in October and December. The three rate cuts in 2025's second half, each of a quarter percentage point (25 basis points), brought the federal funds rate down to a target range of 3.5% to 3.75%, from a peak range of 5.25% to 5.5%, which the central bank maintained from July 2023 to September 2024.

The reductions drove short-term bond yields lower and contributed to gains for the investment-grade bond market in October and November (both +0.62%). Following its December meeting, though, Fed officials signaled they might hold steady for now. With progress on inflation stalled – monthly metrics continued to show U.S. consumer inflation moving within a tight range around 3%, above the Fed's 2% target – and labor-market statistics softening but remaining relatively resilient, Fed Chair Jerome Powell indicated a wait-and-see stance and said, "We're well-positioned to see how the economy evolves from here." This announcement shifted the market's expectation for additional rate cuts deeper into 2026, and the Aggregate index took a small step back in December (-0.15%). For the three months, short-term bond yields fell in step with the benchmark interest rate, but long-term yields rose marginally, a function of the Fed's policy signals as well as heavy issuance of long-term Treasurys to fund U.S. government spending.

Due to this steepening of the yield curve, short- and intermediate-term issues fared best in Q4. Bonds with maturities of 7 to 10 years posted the strongest advance at 1.52%, while 1- to 3-year bonds rose 1.18%, 3- to 5-year maturities were up 1.32%, and 5- to 7-year bonds climbed 1.36%. Conversely, long-term securities of 10+ years were weakest (-0.00%). By credit rating, higher-quality bonds rated AAA and AA outperformed investment-grade debt rated A and BAA (the Bloomberg equivalent to BBB).

At the sector level, U.S. Treasurys (+0.90%) slightly outperformed investment-grade corporate bonds (+0.84%), which were constrained by historically tight credit spreads. (Notably, for the full year, corporates advanced 7.77%, comfortably besting the 6.38% gain for Treasurys). Other yield-advantaged, credit-sensitive sectors – including agency mortgage-backed securities (+1.71%), commercial mortgage-backed securities (+1.34%) and asset-backed securities (+1.25%) – exhibited relative strength in Q4.

Outside the Aggregate index, U.S. Treasury Inflation-Protected Securities gained just 0.13%, per Bloomberg. But investor interest in higher-yielding assets drove strong results for higher-income categories. U.S. high-yield corporate bonds (+1.31%) outperformed investment-grade corporates, while high-yield emerging-markets debt (4.85%) delivered the bond market's best return. For the year, investment-grade and high-yield emerging-markets bonds led all categories, gaining 9.45% and 13.93%, respectively, aided by improving fundamentals and a weaker U.S. dollar. ■

In December, employment and inflation data that was delayed due to the federal government shutdown came in near expectations. However, cleaner data releases in January will be closely scrutinized as investors assess the likely path of Fed rate policy.

Following robust issuance of new bonds in Q4, we think this trend is likely to continue in 2026. Issuance by companies financing AI initiatives is expected to surge. Moreover, there is a healthy pipeline of planned corporate mergers and acquisitions that have yet to be funded.

If this forecast materializes, estimates for 2026 suggest that gross new supply could be in the range of $1.8 to $2.2 trillion, with net supply (net of issuance for refinancing/repricing purposes) around $800 billion. These totals would represent a sizable year-over-year increase in net supply and would put 2026 on par with the record level seen in 2020.

As of December 31, the average spread of the Bloomberg U.S. Credit Bond Index remained near its tightest level in 20 years. 

Given the challenge of finding compelling values in the current spread environment, we added industrial bonds that were trading toward the wider end of a tight range of credit spreads. In this way, we tried to locate issuers offering a measure of relative value. Within the segment, we increased the fund's exposure to bonds in the technology, energy and communications industries.

Elsewhere, we trimmed the allocation to U.S. Treasurys from about 8% to 6%. We kept the fund's credit risk modestly greater than the benchmark, but, with spreads at a tight level, did not extend it further.

Within financials, we lowered the fund's allocation to banks to roughly neutral with the benchmark as of year-end. Meanwhile, we continued to overweight insurers, REITs and finance companies.

From a credit-rating perspective, we maintained an emphasis on issuers rated BBB, believing that there is opportunity for alpha potential over time resulting from improving credit quality. At the same time, we kept a relatively consistent allocation to bonds rated A, in response to tight spreads and economic uncertainty. ■