4 Bonds You Should Buy on a Fixed Income When Interest Rates Fall

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The last five years have taken bond investors on a wild ride. In 2020, the Federal Reserve slashed interest rates near zero, to keep a panicking economy afloat. Fast-forward to 2022, when rates rose above 5% as the Fed tried to tame the worst inflation since the 1980s.

And now rates are falling again, as inflation fears give way to labor market fears. What’s a bond investor to do — especially a bond investor with a limited amount to spare?

If you’re on a fixed income and don’t have much flexibility in your budget, consider buying these four bonds as rates keep dropping.

US Treasury Bonds

As a refresher, bond prices move in the opposite direction of yields. When bond interest rates fall, the prices of older, higher-yielding bonds rise. Buyers pay more for higher-yielding bonds because they can no longer score the same yields by buying new bonds.

That pattern is already playing out. In a widely anticipated move, the Fed cut interest rates in September by half a percentage point to a range of 4.75% to 5%. And sure enough, the S&P U.S. Aggregate Bond Index has risen roughly 6% since April.

Economists and investors expect the interest rates to continue falling and bond prices to continue rising. That makes now a great time to buy virtually risk-free Treasury bonds, at today’s relatively high yields. You can always sell them later for a premium, as new Treasuries pay progressively lower interest rates.

Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments, warned The Wall Street Journal that investors should stick with five- and ten-year Treasury bonds, rather than 30-year Treasurys. He cautioned investors that five- and ten-year Treasurys react most to interest rate cuts, while longer-term Treasurys can react more to higher government spending — a risk under both presidential candidates.

Municipal Bonds

Municipal bonds, fondly referred to as munis, offer tax benefits that can boost their effective yield. Investors pay no federal income taxes on municipal bond interest, and often no state income taxes, if the municipality sits in the same state.

Some higher-income investors worry that they would pay higher tax rates under a President Harris. But the higher your tax rate, the greater the benefit of tax-free interest income from munis. If you worry about higher tax rates in the coming years, consider buying long-term municipal bonds paying relatively high interest rates to maximize your tax-equivalent yield.

Corporate Bonds

Investment-grade corporate bonds come with a low likelihood of default, even if the economy takes a turn for the worse. That means investors can buy in at today’s relatively high yields and comfortably collect interest on them until they feel like selling at a premium as prices rise.

That said, the spread between triple-B corporate bonds in the U.S. and Treasury bonds has slimmed to just 1.06%, according to the Federal Reserve. That’s down from around 1.60% a year ago.

Still, corporations have planned for a slowing economy over the last year or two, and investors can sleep at night with little fear of default on investment-grade bonds.

High-Yield Bonds

High-yield bonds — also known as junk bonds — could offer relatively strong returns without high default risk over the next year. The ICE BofA High Yield Index Value has risen around 6% already this year, and yields remain solid at nearly 7%.

As for risk, S&P Global projects that junk bond defaults will actually decrease between now and June 2025. They see just 3.75% of high-yield bonds defaulting in the 12 months between June 2024 and June 2025. That’s compared to a 4.6% default rate for the previous 12-month period.

And like other bonds, prices should keep rising as yields fall. That makes now a great time to buy bonds in general, while yields remain relatively high.