Quarterly Bond Market Outlook

Q3 bond market outlook for ETF investors

Uncertain fiscal policies and the Federal Reserve’s "wait-and-see" approach to monetary policy have created new macro ambiguity that’s challenging bond portfolios.

July 16, 2025 10 min read

Matthew J Bartolini, CFA, CAIA

Head of SPDR Americas Research

Robert Selouan, CAIA, CFA

Senior Research Strategist

Allocate with defensive optimism

Rapidly changing fiscal policies and the “wait-and-see” monetary policy from the Federal Reserve (Fed) have ushered in a new era of abundant macro ambiguity. Yet, despite a lack of clarity, stock, bond, and credit markets enter the third quarter with gains on the year.

But those gains have stretched valuations for equity and credit markets. The uncertain macro policy backdrop also has led to downside revisions for both economic and fundamental growth forecasts. And weaker, but still positive, growth forecasts are being met with stubborn inflation forecasts and concerns over rising deficits—more questions for markets to decipher.

The uneven growth and inflation trends have prevented the Fed from cutting rates, helping the yield curve remain elevated relative to history but with still-attractive carry opportunities. Therefore, with a defensive optimism guiding bond allocations, consider:

Active core-plus strategies with a wide opportunity set and a focus on quality and risk management to help insulate the largest part of your bond portfolio from macro-led volatility
Actively managed high income credit exposure for the potential to enhance income generation and position opportunistically as macro trends impact sentiment, both positively and negatively
Short duration investment-grade (IG) corporate bonds for balance and income while the Fed waits and sees

Conflicting macro signals

Geopolitical uncertainty has forced the Fed into wait-and-see mode. Cutting rates too soon could create inflation risks amid tariff-led inflationary pressures. And cutting rates too late risks a more pronounced slowdown. The problem is that three months into this new macro paradigm, the hard data doesn’t reflect all the tariff impacts policymakers need to act decisively.

Prices of goods and services have remained relatively stable while edging lower. The recent CPI report showed goods prices, excluding food and energy commodities, were unchanged month-over-month while ex-energy services prices declined.¹ With all tariffs yet to be finalized and implemented, soft data surveys indicate higher inflation on the horizon while hard data remains range bound (Figure 1). And given the fluidity of trade discussions, it’s anyone’s guess where the actual figures will land.

With actual realized inflation impacts yet to be quantified, risks have shifted more toward an economic slowdown and increased unemployment. While the June jobs report did come in stronger than expected—the unemployment rate fell to 4.1%—both the participation rate and the number of people out of work worsened.² At the same time, continuing jobless claims—a measure of how many Americans are receiving benefits—are back above pre-pandemic highs.³ Assessing the strength of the employment situation requires caution.

This data mix is leading the market to rapidly reprice rate cuts, stoking rate volatility across the curve and resulting in a wide range of forecasts for what the Fed may do by year-end. The consensus forecast by economists is for two rate cuts this year.⁴ But expectations range from four cuts to no cuts at all.⁵

This lack of clarity on the path for US central bank policy likely will keep rate dispersion and volatility elevated for the rest of the year.

More clarity in credit where valuations aren’t cheap

While credit markets sold off during the quarter’s initial turmoil, high yield bonds enter the second half of 2025 up 4.7% for the year.⁶ These gains have pushed spread levels to below 300 basis points and 45% below their long-term historical average to sit in the bottom 2^nd percentile.⁷

Tight spreads have pushed high yield bonds to trade with negative convexity (Figure 2), illustrating spread compression is unlikely to be a major driver of future gains. This asymmetric risk profile doesn’t mean high yield should be avoided, as its carry (yield/coupon) remains attractive (yield-to-worst is 7%) and it can still be a source of return.⁸

The carry is even more attractive when compared to other risk assets. Relative to the earnings yield on equities (3.7%),⁹ the current excess yield for high yield bonds sits well above the long-term median (3.2% versus 1.5%). This is a function of both the significantly elevated equity valuations that weaken the earnings yields and the high level of broad interest rates stemming from the Fed’s current policy stance. This is why, relative to US stocks, even US Treasury bonds currently offer better valuations. The 10-year yield (4.39%) is also now higher than the S&P 500’s earnings yield, a rare occurrence over the past 25 years.¹⁰

As a result, even though credit spreads are tight, below investment-grade credit offers:

A way for portfolios to maintain a bias toward any upside in growth, but with less volatility (and better valuations) than equities
Near multi-decade high level of yields that may act as a cushion to help offset potential bond price depreciation from changes in rates and spreads

Balancing risks in an era of abundant ambiguity

A policy mistake from the Fed’s “wait and see” approach could create more uncompensated volatility for longer duration bonds. Particularly relative to shorter duration bonds, as the shallow slope of the yield curve doesn’t produce significantly different yield levels across tenors.

In fact, adjusting for the volatility across the curve shows that the most attractive option of income-per-unit-of-risk is at the short end. More specifically, compared to other high-quality bond markets, the 1-3 year IG corporate space carries one of the more attractive risk-adjusted yields (yield divided by volatility, Figure 3).

Fed actions are not the only potential volatility catalyst for long-term bonds. The intermediate to long end of the curve (10-30 year) is being impacted by the current US fiscal situation, particularly its debt and deficits. The nation’s fiscal health trajectory puts the term premium under increased upward pressure. In fact, the term premium on the US 10-year Treasury is now at its highest level since 2014, after trading at a negative level for most of the past decade.¹¹

This elevated term premium means the old bond market paradigm is history and today:

Long-term yields (risk premiums) will widen if this macro-led volatility continues to erratically impact growth and inflation. This means the bid for US Treasurys may soften as their diversification appeal declines.
Intermediate- to long-term bonds now provide a more positive carry to entice buyers at the longer end of the curve.

While higher yields at the long end of the curve may start to entice demand, the lack of clarity on the endgame of fiscal and monetary policies can lead to instability. So, even if the carry at the long end of the curve is attractive enough to entice demand, the risk to earn that carry represents a bold choice—not a balanced one.

Implementation ideas for Q3

Balancing bond allocations doesn’t mean being totally defensive. It means structuring portfolios with distinct features to help position for the wide range of possibilities out on the horizon. For balance that supports portfolio resiliency, consider:

Core-plus active strategies: Active strategies have the flexibility to manage rate risks while pursuing opportunities in a broader universe to help insulate the largest part of your bond portfolio from macro-led volatility. And combining traditional (e.g., investment-grade corporates and US Treasurys) and non-traditional bond sectors (e.g., CLOs and securitized asset-based-finance) can add income and diversification benefits, supporting tactical positioning along the yield and credit curve to seeks relative value mispricings and alpha opportunities.

TOTL

SPDR® DoubleLine® Total Return Tactical ETF

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PRIV

SPDR® SSGA IG Public & Private Credit ETF

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Active high income credit strategies: Credit sectors can help investors earn the high level of carry from bonds right now, while also preparing for any potential growth upside surprise from the wide range of possible market outcomes. To manage the risk of an opposite outcome leading to wider spreads and losses that can subsume the high carry, consider active multi-sector credit strategies that contain more than one high income sector.

With a wider remit than indexed strategies, active management may be able to manage macro risks and identify relative value opportunities at the single issue, rating, sector, and credit universe levels to enhance returns beyond earning just the coupon.

HYBL

SPDR® Blackstone High Income ETF

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High quality, short duration bonds: If spreads are tight, yields high, and long duration not fairly compensated, owning the short end of the curve may be one way to balance bonds’ high level of carry without taking on significantly uncompensated risks that can, and have, weighed on returns.

In addition to outperforming longer-duration bonds over the past five years, short-duration bonds have had positive rolling one-year returns (daily frequency) on 67% of the observation periods whereas long-duration bonds have had the same on just 15%.¹²

SPSB

SPDR® Portfolio Short Term Corporate Bond ETF

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STOT

SPDR® DoubleLine® Short Duration Total Return Tactical ETF

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Glossary

Alpha
A gauge of risk-adjusted outperformance that is measured relative to a benchmark because benchmarks are often considered to represent the market’s movement as a whole. The excess returns of a fund relative to the return of a benchmark index is the fund's alpha.

Active core fixed income strategy
An actively managed approach to building the main part of a fixed-income portfolio, rather than using a passive, index-based approach such as tracking the Bloomberg US Aggregate Bond Index.

Bloomberg US Aggregate Bond Index (Agg)
A benchmark that provides a measure of the performance of the US dollar denominated investment grade bond market. The “Agg” includes investment-grade government bonds, investment-grade corporate bonds, mortgage pass through securities, commercial mortgage-backed securities and asset backed securities that are publicly for sale in the US.

Bloomberg US Corporate Bond Index
A fixed-income benchmark that measures the investment-grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-US industrial, utility and financial issuers.

Duration
A commonly used measure, expressed in years, which measures the sensitivity of the price of a bond or a fixed-income portfolio to changes in interest rates or interest-rate expectations. The greater the duration, the greater the sensitivity to interest rates changes, and vice versa. Specifically, the specific duration figure indicates, on a percentage basis, by how much a portfolio of bonds will rise or fall when interest rates shift by 1 percentage point.

Carry
The returns earned from holding a bond, usually in the form of coupon payments received over the holding period, minus the costs incurred from financing that position.

Credit spreads
The difference in yield between a US Treasury bond and a debt security with the same maturity but of lesser quality.

Investment-grade bonds
Bonds that have a relatively low risk of default. Bond-rating firms, such as Standard & Poor’s, use different lettered descriptions to identify a bond’s credit quality. In S&P’s system, investment-grade credits include those with ‘AAA’ or ‘AA’ ratings (high credit quality), as well as ‘A’ and ‘BBB” (medium credit quality). Anything below this ‘BBB’ rating is considered non-investment grade.

Yield curve
A graph or line that plots the interest rates or yields of bonds with similar credit quality but different durations, typically from shortest to longest duration. When the yield curve is said to be “flat,” it means the difference in yields between bonds with shorter and longer durations is relatively narrow. When the yield curve is said to be “steep,” it means the difference in yields between bonds with shorter and longer durations is relatively wide.

Yield-to-worst
The lowest potential yield that investors can expect when investing in a callable bond without the issuer defaulting.

Footnotes

Disclosures

Important Risk Discussion

The views expressed in this material are the views of Matthew Bartolini and Robert Selouan through the period July 7, 2025, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projections.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.

All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

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