Active Fixed Income Perspectives Q3 2025: The power of income
Vanguard Perspective
|July 22, 2025
Active Fixed Income Perspectives Q3 2025: The power of income
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Big picture
- Returns: Broad fixed income indexes have returned 4.00%–7.25% in the first half of 2025, driven by higher coupon income.
- Taxable bonds: Current yields near 5.00% or higher are appealing. If rates were to decline, returns on higher-rated bonds would be enhanced.
- Municipals: High-quality muni bonds, particularly those with long maturities (15+ years), are attractive due to historically favorable yields.
Credit
- Slow but steady: We expect credit to perform well for the rest of the year in a slower growth economy. Still, we remain defensive and prefer high quality as credit spreads remain tight.
Economy, policy, and outlook
- Growth: We expect the economy to grow by 1.5% in 2025.
- Unemployment: We expect unemployment to rise to 4.7% by year-end.
- Inflation: Personal Consumer Expenditures inflation is projected to reach close to 3%, year-over-year, by the end of 2025.
- Federal Reserve: We think that two rate cuts over the rest of 2025 is a reasonable expectation.
More upside than downside potential
Note: The model assumes a one-time move in interest rates, then assumes the investor holds the position for the next 12 months and captures the price change and the income return using the current yield-to-worst, which is the lowest potential yield an investor can receive on a bond without the issuer defaulting.
Source: Vanguard calculations based on the Bloomberg U.S. Aggregate Bond Index and Bloomberg Municipal Index, as of June 30, 2025.
Takeaways to consider:
1. See the power of income: With interest rates still high relative to the past 20 years, bonds can weather some volatility and provide meaningful income.
2. Take on some duration: Staying short can still produce attractive income returns but provides less of a hedge to risk assets if growth disappoints. Some duration can provide extra ballast during periods of economic weakness or market turmoil. We see the best value in the short- to intermediate-term part of the yield curve.
3. Stay diversified: Ample opportunities in global bonds, corporates, and mortgage- and asset-backed securities justify broad investment. Emphasize high-quality bonds over high yield.
4. Look at municipals (for taxable clients): Municipals can offer great value for high income investors. For those with longer-term investment horizons, long-term bonds, while more volatile, are exhibiting rarely seen tax-exempt yields nearly on par with U.S. Treasuries.
PDF
Active Fixed Income Perspectives Q3 2025: The power of income
Strong bond returns and attractive yields highlight the power of income, especially amidst volatility.
Notes:
For more information about Vanguard funds, visit advisors.vanguard.com or call 800-997-2798 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.
All investing is subject to risk, including possible loss of principal. Diversification does not ensure a profit or protect against a loss.
Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.
Investments in bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund’s trading or through your own redemption of shares. For some investors, a portion of the fund’s income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.