By Vivien Lou Chen
An uncertain outlook for inflation and interest rates could drive yields higher next year, weighing on bond prices
The U.S. bond market is on track to wrap up 2025 with the highest return in five years.
Bonds are poised to end 2025 with their best performance in five years – fueled by the Federal Reserve’s interest-rate cuts, moderating inflation pressures and a slowing labor market.
Yet there’s reason to believe they may not perform quite as well in 2026.
The Bloomberg U.S. Aggregate Bond Index – which tracks Treasurys, government-related debt and corporate bonds, as well as mortgage-backed and asset-backed securities – has returned more than 7% in 2025 as of Thursday, according to Dow Jones Market Data. In 2024, the index returned 1.25%, while returning 5.5% in 2023.
This year’s rally arrived as bond investors were still trying to move past a historically difficult period for bonds – one characterized by a sharp downturn in 2022, when the Fed implemented its quickest rate-hiking cycle in roughly four decades to combat inflation. The Bloomberg index dropped by just over 13% that year, its worst return on record.
Bonds have since made up for some of that lost ground. Yet investors shouldn’t expect all of this year’s momentum to carry over into 2026.
For one thing, some market participants are skeptical of the extent to which the Fed can keep cutting rates in 2026. Additionally, Treasury yields have already fallen pretty dramatically this year, which means anybody looking to buy bonds now will be getting in at a less attractive price. Bond yields move inversely to prices, and rise as prices fall.
]The 10-year Treasury yield BX:TMUBMUSD10Y – an important benchmark that influences everything from mortgages and auto loans to corporate bonds and the government’s cost to borrow – has fallen to 4.12%, from roughly 4.58% in January, as expectations for more interest-rate cuts and signs of a slowing economy drove bond prices higher.
“It was a good year for two reasons: positive income returns and price appreciation,” said Collin Martin, the New York-based head of fixed-income research and strategy for the Schwab Center for Financial Research.
Investors “benefited from high yields coming into the year, which meant income payments were relatively higher than they’ve been for a long time, and from a gradual decline in yields during the year because of Fed rate cuts, which pulled up prices as well,” Martin said.
Treasury yields were heading higher in late 2024 and early 2025 on fears that President Trump’s tariff and trade policies would reignite inflation and possibly trigger a bond-market rout. Instead, inflation has remained stable enough for the Fed to turn its attention to a softening labor market. The central bank delivered three quarter-point reductions to its key interest-rate target this year.
A reading on November inflation released Thursday showed that consumer prices rose by 2.7% over the past 12 months, down from 3% in the 12 months through September.
Bonds act as a ballast in many investors’ portfolios by providing stability, income and diversification that is supposed to offer some measure of protection when the stock market stumbles.
They remain part of the classic diversified 60-40 investment portfolio recommended to most investors saving for retirement; such a portfolio is made up of 60% stocks and 40% bonds. Bonds offer a return through regular coupon payments, as well as any price appreciation that might occur. When they reach the end of their lives, bonds are redeemed at par.
Even if prices don’t appreciate in 2026 as much as they did in 2025, investors still have at least one good reason to include bonds in their portfolios.
“We think the main reason to hold bonds in a portfolio is for the income they provide, and less about potential price appreciation over time,” said Schwab’s Martin. “We think bonds can still provide diversification and the stability it generally has over time, and we haven’t abandoned the 60/40 portfolio concept.”
In addition, “we think next year will be another good year,” Martin said during a phone interview, though noting “we don’t know if returns will be as high and as strong as this year.” Positive returns are still likely, but “may not necessarily match the strong returns we’ve seen this year.”
Daniel Tenengauzer, a senior foreign-exchange analyst at InTouch Capital Markets in New York, noted that even though bonds are on track for their best year since 2020, “the circumstances are very different than they were then.”
Five years ago, “the world went into a recession and, as a result, bonds rallied because people were wagering on fiscal stimulus. Back then, there was a clear aim,” Tenengauzer said.
These days, it is unclear whether any additional stimulus from the Fed or the Trump administration will have much of an impact, given that the economy remains on solid footing, he added. Such moves could help revive inflation, which has remained sticky, and that could create a problem for bond bulls.
“There is a risk that additional fiscal stimulus will take the 30-year yield BX:TMUBMUSD30Y higher and drive a selloff in the long end,” Tenengauzer said. “So the outlook for next year is not all that great from that perspective.”
-Vivien Lou Chen
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12-18-25 1436ET
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