Every corner of the US bond market has rallied year to date, led by intermediate Treasuries, based on a set of ETFs through Wednesday’s close (June 18). Several risk factors are lurking for the second half of the year, but fixed income looks set to score a win for the year when 2025 reaches the halfway mark in a few days.
The iShares 7-10 Year Treasury Bond ETF (NASDAQ:IEF) is leading the field with a 3.9% total return so far this year. The performance is fractionally ahead of intermediate corporates (VCIT), the second-best performer. Both returns reflect moderate premiums over the US investment-grade benchmark (BND), which is up 2.9% in 2025.
All the major slices of the bond market are posting gains this year. The weakest performer: long-term Treasuries via iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) with a 1.0% rise.
Several potential headwinds await bonds in the second half of the year, starting with the potential for higher inflation. The key catalysts to watch: higher energy prices triggered by tariffs and the Israel-Iran conflict, which has already lifted oil prices sharply in recent days.
Higher energy costs translate to higher headline inflation, which puts more pressure on the Federal Reserve to delay interest rate cuts. Depending on how high energy costs rise, rate hikes are a possible scenario. In that case, bond prices would likely fall.
The Federal Reserve on Wednesday released new economic projections that hint at a higher risk of stagflation – slower growth and higher inflation.
“From the Fed’s perspective, substantial ongoing uncertainty paired with a good-enough-for-now labor market is ample justification to continue its wait-and-see approach,” said Indeed Senior Economist Cory Stahle.
Another risk factor that will attract close attention in the bond market in the weeks ahead: the federal budget deficit and how it’s affected by the spending bill currently under consideration in the Senate.
New analysis published by the Congressional Budget Office this week projects that debt service costs will increase interest rates and boost interest payments on the baseline projection of federal debt by $441 billion. An earlier CBO estimate predicts that the spending bill will also increase the federal deficit by $2.4 trillion over the decade ahead.
“We’re running a budget deficit of 6.4% of GDP. Over time, we’re adding more debt,” says Matt Eagan, a fixed-income manager at Loomis Sayles. “Historically, when a government does not balance its budget—or in the case of the US, get it down to a more manageable level—or when the tax base doesn’t want to get taxed, then the other form of tax is inflation.
You debase the bond market, the fiat currency, which is why gold and other things are sending a signal about the value of fiat currencies. This isn’t just a US phenomenon. Other developed markets face these same structural issues.”