Fixed Income Investments in the US: Guidance for 2025

Considerations for the US Fixed Income Market in 2025

The US economy is projected to experience moderate growth driven by productivity and consumer spending patterns. This suggests a stable but moderate range for bond yields, with 10-year US Treasury yields anticipated between 4.0% and 4.75%. Long-duration bonds may present additional risks due to low term premiums and sensitivity to interest rate movements. The Federal Reserve is likely to adopt a more cautious approach to rate cuts relative to 2024, maintaining tighter monetary policy compared to some other central banks, such as the European Central Bank (ECB), which may reduce rates more aggressively.

Investors may consider focusing on shorter-duration bonds and exploring positions that reflect potential yield curve steepening, especially within US Treasuries, to balance interest rate risk while accessing prevailing yields.

Fixed Income Sectors to Explore

Investment-Grade and High-Yield Corporate Credit

Credit markets potentially offer more diverse opportunities compared to purely duration-based investments. Investment-grade and high-yield corporate bonds in the financial sector may be supported by currently observed corporate fundamentals, including earnings trends, balance sheet strength, and regulatory and tax factors. Although credit spreads are tighter by historical measures, yields may remain sufficient to warrant measured exposure to these segments, particularly with active security selection.

Securitized Credit — Focus on U.S. Mortgage-Backed Securities (MBS)

Within securitized credit, U.S. mortgage-backed securities (MBS) may present opportunities in 2025, supported by:

• Relatively low unemployment rates
• Borrowers maintaining prime credit quality
• Housing prices that have shown stability or moderate increase
• Higher coupon agency-backed mortgage securities offering yields above those of comparable Treasuries

These elements contribute to a yield differential, while this sector benefits from generally stable consumer credit fundamentals.

Caution is advised regarding office-backed commercial mortgage-backed securities (CMBS) due to refinancing considerations influenced by potential Federal Reserve policies and current interest rates. At this time, limiting broad exposure to this segment may be prudent, with attention to select opportunities as information on collateral quality improves.

Approach to Bond Duration

Considering economic and monetary factors, long-term bond holdings may carry heightened risk from rising yields and price fluctuations. Maintaining a neutral duration stance, focusing on shorter maturities, and considering yield curve dynamics may help manage interest rate risk in 2025.

Factors to Monitor for Risk Management

• Geopolitical developments: Ongoing international conflicts and supply chain issues could impact fixed income markets.
• Corporate debt levels: Possible increases in corporate leverage influenced by regulatory and fiscal policies may raise credit risk.
• Inflation dynamics: Elevated inflation could limit central bank flexibility, affecting yields and bond market volatility.
• Market volatility: Fluctuations in equities and interest rates may affect fixed income returns, especially trades relying on stable interest rate spreads.
• Currency considerations: A strong US dollar, influenced by tighter monetary policy and economic strength, might affect non-dollar fixed income holdings and highlights the importance of currency risk management when relevant.

Importance of Active Portfolio Management

Given tighter credit spreads and evolving economic conditions, active selection and management of fixed income securities can be important. Investors may focus on:

• High-quality credits supported by fundamentals
• Allocations in sectors like financials and securitized credit
• Avoiding unselective exposure to broad market or excessive duration risk
• Adjusting portfolio positions dynamically in response to market developments

Active management can assist with risk navigation and identifying relative-value opportunities.

Notes for Retail Investors

This overview does not specify particular fixed income products, such as municipal bonds or Treasury Inflation-Protected Securities (TIPS). Retail investors typically access fixed income through vehicles such as:

• Short- and intermediate-term Treasury bond funds or ETFs
• Investment-grade corporate bond funds
• Mortgage-backed securities funds
• Actively managed fixed income mutual funds aligned with the sectors described above

When constructing a portfolio, retail investors might consider:

• Investment objectives: Income requirements versus preservation of capital
• Risk tolerance: Sensitivity to interest rate and credit risks
• Investment horizon: Longer horizons might accommodate certain duration risks for yield potential
• Cost considerations: Comparing fees between active management and passive approaches
• Diversification: Managing exposure across different sectors and maturities

Summary of Considerations for Fixed Income in 2025

In 2025, fixed income strategies may involve:

• Limiting exposure to long-duration US Treasuries to reduce interest rate risk
• Emphasizing shorter maturities and exploring opportunities related to yield curve shifts
• Considering measured allocations to investment-grade and high-yield corporate credit, particularly in financials
• Evaluating increased exposure to U.S. mortgage-backed securities with higher coupon agency MBS
• Exercising caution with office-backed CMBS due to refinancing uncertainties
• Monitoring macroeconomic risks such as geopolitical events, inflation trends, and corporate leverage levels

Active portfolio management and selective security analysis can contribute to navigating market complexities. Aligning fixed income holdings with these approaches may help investors seek consistent income and manage downside risks within the prevailing economic context.

Sources

• Morgan Stanley 2025 Global Fixed Income Outlook
• Kiplinger: Where to Invest in the Back Half of 2025

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