What Fed Rate Cuts Mean For Fixed-Income Investors

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What does the Federal Reserve's rate-reduction initiative mean in the short run for your fixed-income holdings?

You'll recall that one year ago, the Fed cut three times, starting by hacking its benchmark overnight funds rate by 0.50 percentage point in September. The year ended with bond markets and fund returns in retreat. It's wishful thinking that cheaper short-term credit and falling money market yields will spark a general bond-buying binge and propel your 2025 total returns toward 10% by year-end.

My judgment is that long-dated bonds are expensive and risky and that we are set for an encore of 2024, when the fourth quarter was a downer, with 19 of 23 fixed-income categories in the red, according to Morningstar.

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So I do not expect further advances over the 5% to 8% returns earned through the third quarter. Instead, and pardon the cliché, it looks like déjà vu all over again, with a lot of losses and a few breakevens.

"If you have 6% in the bag already, which is 2% a quarter, I figure now it is sideways or giving a little back" the rest of the year, says Warren Pierson, co-chief investment officer for Baird Asset Management.

Last year, every time the Fed cut, rates on the 10-year note and longer maturities increased, meaning a loss of principal, adds Nick Losey, who manages high-yield and asset-backed securities for Barrow Hanley. (Rates and bond prices move in opposite directions.)

He expects a repeat. Inflation is edging higher, the dollar is weak, and there is no sign of fading economic momentum to the degree that traditionally provokes big flows into Treasury bonds and forces those yields down.

Hang tight

These are not sell signals, just a reality check. Credit conditions are good, yields are respectable, and enough pension funds, banks and insurance companies will keep buying even as individuals withdraw money from bond mutual and exchange-traded funds.

And there is a cavalry of sorts. Bond honcho Christian Hoffmann at Thornburg Investment Management insists that when 30-year Treasuries reach 5%, a herd of buyers will arrive and stanch the sell-off. That may be true, and if you think 5% through 2055 is a fair deal, that is your business. I disagree, and I advise against long T-bonds virtually anytime — and especially now.

Fixed-income thinkers and managers just cannot shake their unpleasant memories of how last fall's Fed rate cuts hurt, rather than helped, bond values.

Morningstar's fourth-quarter 2024 figures tell this story as well as anyone. The four gainers in that list of 23 were floating-rate bank loans and high-yield bonds, which are more correlated with stocks than with Treasuries; ultra-short bonds, which are tantamount to cash and rarely lose any principal under any conditions; and, in a surprise, non-traditional bond funds, which are go-anywhere, actively traded portfolios. All four categories are still in fine shape and are definite keepers.

Municipal bonds also held up in last year's fourth quarter, with some of the smallest losses on the charts. Tax-exempts are well positioned to end 2025 on a better note, even if taxable bonds struggle. The oversupply of municipals that dragged down principal values in the first half is no more.

Also in the past is the overblown (but damaging) fear that the budget-and-tax bill would end or limit the tax exemption. But municipals got so cheap that the buyers returned, so the various muni indexes are back in the green for the year to date.

One fund I like is Baird Strategic Municipal Bond (BSNSX), showing a year-to-date return through September of 3.5% and a tax-free yield of 3.3%.

Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

Kosnett is the editor of Kiplinger Investing for Income and writes the "Cash in Hand" column for Kiplinger Personal Finance. He is an income-investing expert who covers bonds, real estate investment trusts, oil and gas income deals, dividend stocks and anything else that pays interest and dividends. He joined Kiplinger in 1981 after six years in newspapers, including the Baltimore Sun. He is a 1976 journalism graduate from the Medill School at Northwestern University and completed an executive program at the Carnegie-Mellon University business school in 1978.