Bonds Are Rallying on Economic Fears. They Have More Gains Ahead.

Souring expectations for the U.S. economy are pushing up Treasury prices. (Eric Lee/Bloomberg)

Key Points

• Yields on 10-year Treasury notes decreased by 0.029 percentage points to 3.959% on Tuesday, falling below 4% for the first time since April.
• The decline in bond yields is largely attributed to weakening economic data, a government shutdown, and expectations of a Federal Reserve rate cut.
• Bond investors have seen strong returns, with the iShares 20+ Year Treasury Bond ETF returning 8.2% and the iShares Core U.S. Aggregate Bond ETF returning 3.9% over three months.

The party for bonds could continue through the rest of 2025, unless the economic data suddenly start looking a lot better.

On Tuesday, yields on 10-year Treasury notes slid 0.029 percentage points to 3.959%. Last week, the 10-year yield dipped below 4% for the first time since April, when President Donald Trump rocked the markets by kicking off his trade war. (Bond prices move in the opposite direction to yields.)

While Trump’s trade policies are still making headlines, this time around, investors have plenty more to worry about. A standoff between Republicans and Democrats in Congress has shut down the government, with no end in sight. Meanwhile, the jobs marke t appears to be steadily cooling. That has led to a near certainty the Federal Reserve will cut short-term interest rates at its Oct. 28-29 meeting.

Bond yields tend to fall in a weakening economy because investors assume the weakness will translate into less demand for borrowed money. They also decline because investors start seeking out safer assets, bidding up bond prices.

It’s worth noting that the recent decline in bond yields has come despite lingering fears of inflation—one factor that can keep bond yields elevated no matter what the economic outlook.

In a report Tuesday, markets researcher DataTrek, noted that while nominal 10-year yields have fallen about 0.59 percentage points since the start of the year, and almost all of the decline was tied to souring economic assumptions. Changing inflation expectations accounted for just 0.07 percentage points of the 0.59-point decline. Meanwhile, the so-called “real yield”—which calculate a bond’s yield minus the expected rate of inflation—declined 0.52 percentage points.

“We expect this will continue through the rest of the year as markets reassess U.S. economic growth and, therefore, future Fed monetary policy,” wrote DataTrek co-founder Nicholas Colas.

Falling yields have already led to some dramatic outperformance for bond investors. In the past three months, the iShares 20+ Year Treasury Bond exchange-traded fund , commonly referred to by its ticker TLT, has returned 8.2%, according to FactSet. That beats the S&P 500 ’s 7.3% return during the same time.

That outperformance won’t last forever. Even long-term bonds, which tend to be more sensitive to interest rates than shorter-term bonds, can’t keep pace with stocks in the long run. But the iShares Core U.S. Aggregate Bond ETF , a broad-based index fund that’s a core holding in many investors’ portfolios, has also delivered a solid 3.9% return over the past three months.

Unless the economy suddenly turns around, that solid performance should continue. What’s more, investors should be able to count on bonds, regardless of where stocks—currently near record highs—head next. That makes bonds look like a steady bet over the next several months.

Write to Ian Salisbury at ian.salisbury@barrons.com