2025 Bond Market Outlook: Yields Range-Bound but Volatile

For 2025, bond investors might want to make themselves comfortable with where yields have been in 2024.

The US economy is expected to post steady growth, without overheating or sliding into recession. At the same time, inflation is expected to remain under control but not fall significantly. Against that backdrop, the Federal Reserve is seen as unlikely to make big changes in monetary policy. Add these factors up and it could mean a bond market that largely bounces back and forth in well-defined ranges, most likely within the highs and lows carved out in 2024.

Take the US Treasury 10-year note. It started 2024 yielding around 3.9%, rose to a high yield for the year of 4.7% in April, and fell back to 3.6% in September before ending the year at roughly 4.6%.

“We have more clarity on the broad range of where it’s going to be, we’re pretty sure about that, and we’re much less sure where it’s going to be in there,” says Dominic Pappalardo, chief multi-asset strategist for Morningstar. Pappalardo says he predicts the 10-year Treasury yield will remain roughly between 3.5% and 5.0% in 2025.

When it came to performance, 2024’s roller coaster has led to muted returns. The Morningstar US Core Bond Index—which tracks a mix of investment-grade government and corporate debt—is up just north of 1% in 2024, which followed a 5.3% gain in 2023. These positive but small gains come after bonds were hammered in 2022, with the core bond index down 13% in 2022 as the Fed jacked up rates to stamp out surging inflation.

2025’s Economic Backdrop

Heading into 2025, the Fed appears to have achieved the hard to pull off “soft landing,” where the economy avoided recession after its aggressive rate hikes and yet inflation pressures came down from their multidecade highs. If anything, the US economy has held stronger than most observers had expected.

At the same time, while inflation cooled enough for the Fed to begin lowering interest rates, in recent months, the decline in the inflation rate has leveled off, leaving inflation higher than the Fed’s 2% target. The Fed has cut the key federal-funds rate by 1 percentage point since September, with the current target range set at 4.25%-4.50%.

“We do think the economy is in pretty good shape,” says Maulik Bhansali, senior portfolio manager at Allspring Global Investments and one of the portfolio managers of the $5.1 billion Allspring Core Bond Fund MBFIX, among others. “Our view is that inflation, while it has been sticky, we do think that we’re still in the midst of a disinflation trend.”

For the bond market, “while there might be bumps, we think that the risks are pretty well contained.”

Risks in the Bond Market Outlook

At its December meeting, Fed officials signaled two more rate cuts coming in 2025, fewer than investors had been expected just a few months before. One issue has been slowing progress in reducing in inflation.

More recently, some rumblings have emerged among investors noting the potential for inflation rates to start heading higher again, which would be a significant negative for bond prices. The potential for the Fed to even raise rates by the end of 2025—while seen as unlikely—is making its rounds. One reason is the concerns about the potential for inflationary policies out of the incoming Donald Trump administration.

Trump’s proposed tariffs would increase inflation by raising the price of goods, while immigration would be inflationary by decreasing the supply of labor, potentially causing wages to rise. This makes predicting inflation, or the inflation expectations of bond investors, very difficult.

“I would clearly identify rebounding inflation as the number-one risk in 2025, and that is most likely to occur from policy changes,” says Pappalardo.

The potential for these Washington policy changes is scrambling the outlook for some in the bond market.

“There’s also the uncertainty surrounding policy, and so in our mind, it’s almost too difficult to call. In fact, this year, we’ve eliminated the year-end call because there’s too many extenuating circumstances this year that make it very hard to pinpoint exactly where rates will be at the end of 2025,” says John Flahive, head of fixed income at BNY Mellon Wealth Management. More broadly, Flahive says they expect the 10-year Treasury to be held to a 3.25% to 5.00% range in 2025.

While the magnitude of policy impact on inflation is unclear, the direction of those effects is much clearer.

“I would say there’s almost no chance that future, upcoming policy changes will reduce inflation,” says Pappalardo. “Broadly speaking, all of the policy changes being talked about go in one direction.”

Treasuries: The Curve Normalizes

One of the most visible trends in the bond market over the last few years was what bond traders call an “inverted yield curve.” Normally, long-term yields are higher than short-term yields in order to compensate investors for the risk of lending out money for longer periods of time, particularly when it comes to the corrosive effects of inflation on fixed coupon payments on bonds.

However, for just over two years, the shortest-maturity bonds have had some of the highest interest rates. That’s finally ending as the Federal Reserve made its most recent cuts. With short-term yields falling, the curve has been “steepening,” in Wall Street lingo.

“The entire curve is now yielding more than cash, that’s a relatively new development,” says Allspring’s Bhansali, who argues that investors should be moving to bonds with somewhat longer maturities.

However, the gains by going out the interest-rate curve aren’t all equal.

“The curve has steepened a little bit, but it’s still flat by historical standards,” says Russ Brownback, one of the managers of the $40 billion BlackRock Strategic Income Opportunities Fund BSIIX. Brownback suggests looking to the middle of the yield curve for opportunities in Treasuries.

“We don’t believe the risk/reward trade-off for that long-end exposure is worth it right now. The 30-year (Treasury) is at 4.7%, the 7-Year is at 4.45%, so you’re picking up a couple basis points a month for multiple times the risk,” says Pappalardo.

Corporates: High Valuations but Strong Fundamentals

Corporate bond yields are also likely to stay within a defined range as well, money managers say. Strong corporate earnings and low risk of recession mean corporate yields are unlikely to rise substantially due to fear of defaults, but as corporate bond valuations are close to historic highs, there’s little room for yields to fall.

The valuation on corporate bonds is measured by how much a corporate bond offers in yield over a Treasury of equivalent duration, a measure of how sensitive a bond is to interest-rate changes. This difference in yield is called the “spread,” with smaller spreads indicating richer valuations. At year-end, investment-grade corporate bond spreads are at 0.82%, close to historic lows, according to the Federal Reserve Bank of St. Louis Economic Data. By comparison, spreads spent most of 2022 and 2023 between 1% and 1.5%.

“I think that the spreads, albeit tight entering the beginning of the year, are justifiably tight,” says BlackRock’s Brownback. At the same time, he expects investors to continue favoring corporate debt. “With that overnight rates and money market yields coming down, we’ve seen and think we’re going to continue to see a steady flow of money seeking the yields.”

BNY’s Flahive also sees support for corporate bonds despite narrow spreads. “Based on the economy and what we think corporate profitability is, we think both of those are going to be sound,” he says. “And consequently, it’s really, really difficult to become overly bearish about corporate spreads. So our bias is to continue to maintain a slight overweight to corporates.”