Bonds Mark Best First Half Since 2020. Inflation Worries Fade.

Traders working at the New York Stock Exchange (NYSE), on Friday, June 27, 2025.

Bond traders have worried about inflation for much of the year but high prices have been a no-show so far, paving the way for the Treasury market’s best first half since 2020.

The 10-year yield has declined 0.350 percentage point through June 30 in 2025, the largest drop seen within the first half in five years. Yields move in opposite direction of bond prices.

Gains in bonds have been driven by the narrative on rising inflation falling apart. Inflation is the bond market’s nemesis because it chips away at the value of expected returns. As expectations of higher prices declined, the value of existing bonds increased.

Help came as Israel and Iran backed away from a full-blown war, an event that was certain to raise oil prices, along with those of goods and services around the world. While U.S. crude initially climbed above $75 per barrel, it contracted below $65 as the conflict eased.

“The lessening of inflationary pressures that might have emerged from the conflict in the Middle East has been a net positive for Treasuries,” wrote BMO Capital Markets strategists Vail Hartman and Ian Lyngen.

Created with Highcharts 9.0.110-year Treasury yieldSource: Tullett PrebonAs of July 18, 7:21 a.m. ET

Created with Highcharts 9.0.1Feb. 2025July3.94.04.14.24.34.44.54.64.7%

There has also been little evidence to show companies, which are now paying additional costs to import goods due to tariffs, are passing those costs to consumers. U.S. businesses paid $22.2 billion in customs duties in May, a record monthly amount, reflecting higher government revenue from tariffs. But data showed inflation increased 0.1% over the month in May, less than the 0.2% expected.

Still, economists have long predicted tariffs impact inflation with a lag.

“With tariffs trickling in in February and March and then stepping up notably in April, it is simply premature, in our view, to expect inflation to have picked up meaningfully yet,” say Morgan Stanley economists led by Seth Carpenter.

They predict the next two releases to show rising prices.

But until supporting evidence appears, the bond market has tempered its pessimistic outlook by reducing demand for yields.

Besides inflation, traders were also forced to reassess their projections for interest-rate cuts. Most traders now expect the Federal Reserve to take rates as low as 3.5% to 3.75% by December from the current range of up to 4.5%. At the start of the year, few expected such deep cuts. That revision comes on the back of lower economic growth projections, which raise the need for the Fed to step in and ease rates.

The situation isn’t helped by the president’s early focus on a future Fed chair, who is expected to favor relatively lower interest rates.

“The big change at hand is the Street already focusing on a more dovish Fed Chairman to replace Jay Powell,” wrote Rick Bensignor, president of Bensignor Investment Strategies.

Bensignor noted that if further weakness ensues, April’s low yield close of 4.16% and 3.72% could be in sight: “I’d lean for rates to fall.”

Write to Karishma Vanjani at karishma.vanjani@dowjones.com