Almost all factors are "favorable," and the U.S. bond market is expected to achieve its "best performance" since 2020

The U.S. bond market is experiencing its best year since 2020, driven by multiple favorable factors such as the Federal Reserve's interest rate cuts, moderate economic slowdown, and continued easing of inflationary pressures, leading to a comprehensive rise in the bond market.

According to media reports on Monday, the Bloomberg U.S. Aggregate Bond Index has achieved a return of approximately 6.7% year-to-date, accounting for price changes and interest payments, and is expected to record its best annual performance since 2020. This surge has finally rewarded bond investors who faced a historic downturn in 2022.

The Federal Reserve has cut interest rates twice this year and may cut them further. Although job growth and consumer spending have slowed, there are no signs of an economic recession that could threaten corporate balance sheets. Despite market concerns that Trump's tariff policies may drive up prices, inflationary pressures continue to ease.

Unlike previous years, this year the return on U.S. Treasury indices has easily surpassed that of short-term government bonds, which are another major option for investors seeking safe alternatives outside the stock market.

Rate Cut Expectations Outweigh Deficit Concerns

The Federal Reserve's rate cuts have become the core driving force behind the rise in the bond market. Bonds issued when interest rates were high become more valuable when the market expects rates to decline. Earlier this year, investors were uncertain whether the Federal Reserve could cut rates amid persistent inflation and the potential for Trump to implement expansionary fiscal policies. However, the cooling labor market has prompted the Federal Reserve to cut rates twice this year, with the possibility of further cuts.

U.S. Treasury yields have subsequently declined. The yield on the 10-year U.S. Treasury bond has fallen by nearly 0.5 percentage points this year, closing at 4.149% last Friday.

Earlier this year, the U.S. Treasury market experienced a brief but severe sell-off, raising concerns that the bond market might ultimately be unable to bear the pressure of the U.S. government's massive borrowing. The size of the budget deficit affects yields, as a larger deficit means the government needs to borrow more funds by issuing Treasury bonds, which in turn requires higher interest rates to attract demand. However, the decline in interest rates has largely overshadowed all these concerns.

Trump Administration Closely Monitors Bond Market

The Trump administration has been closely monitoring the bond market and has intervened multiple times during turbulent periods. President Trump suspended most of his so-called reciprocal tariffs in April this year due to "nervousness" among bond investors. Treasury Secretary Mnuchin has stated that keeping long-term Treasury yields low is a government priority, as these yields serve as benchmarks for various borrowing costs, from mortgages to student loans.

Although government and corporate bond yields have gradually declined, they remain well above the subdued levels seen for most of the past decade, and investors are eager to lock in these yields.

Cal Spranger, fixed income fund manager at Badgley Phelps Wealth Managers, stated, "As a bond fund manager, attending client meetings this year has clearly been more interesting; a few years ago, I wasn't invited anywhere at all."

Multiple Risks Still Threaten the Uptrend

Despite an optimistic outlook, the bond market rebound still faces numerous threats.

The path for interest rate cuts has become unclear due to differing opinions among Federal Reserve officials, with some pouring cold water on the possibility of a rate cut in December. Federal Reserve Chairman Jerome Powell warned in October that the Fed is still "far away" from deciding on a rate cut next month, a rare candid statement for central bank officials.

Investors currently believe the likelihood of a rate cut in December is about 50%. According to the CME FedWatch tool, futures market pricing last Friday indicated a rate cut probability of about 46%, down from approximately 67% a week earlier.

Some are concerned that the U.S. corporate bond market is overheating, with corporate bond valuations at historically high levels potentially masking excessive market behavior and failing to adequately compensate investors for the risks taken. The additional yield or spread of investment-grade corporate bonds over Treasury bonds fell to 0.72 percentage points in September, the lowest level since the late 1990s, before slightly rebounding to 0.83 percentage points.

Some analysts warn that the U.S. government budget deficit could again weigh on the bond market. The deficit for fiscal year 2025 is projected to be $1.8 trillion, roughly unchanged from 2024. "This will definitely become a problem at some point," said Mike Goosay, Chief Investment Officer and Global Head of Fixed Income at Principal Asset Management, "You can only borrow so much before investors start to walk away."

However, many investors believe that good times will continue, confident that despite recent rising uncertainties, there is still room for further interest rate declines. Matt Brill, Senior Portfolio Manager and Head of North American Investment Grade Credit at Invesco, stated that his team is optimistic about short-term bonds, believing that upcoming economic data will drive the Fed to continue cutting rates. "While there haven't been massive layoffs, there haven't been job creations either," he said, "I think the Fed is paying attention to this, which concerns them."

Risk Warning and Disclaimer

Markets are risky, and investments should be made with caution. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investing based on this is at your own risk