• Today’s higher starting yields have materially improved the risk/return trade-off for fixed income in 2025 and beyond.

• In this environment, coupon payments comprise more of a bond investor’s total returns - which should also provide a cushion against losses if interest rates were to rise and bond prices fall.

• As the global easing cycle continues in 2025, we do not expect bonds to experience a material price appreciation from falling yields, but we do continue to expect solid income returns to support bonds globally. 

What do higher starting yields mean for the bond outlook?

In our 2025 Vanguard economic and market outlook, we explore how higher starting yields should set the foundation for solid fixed income returns over the next decade. Here, we take a closer look at how the higher income generated by bonds creates a more positive risk-reward trade-off for investors in 2025 and beyond.

After two years of sharply declining inflation across developed markets, 2024 brought the start of a global easing cycle that will be in full swing in 2025.

At the same time, long-term government bond yields in the UK, euro area and US have been hovering near the relatively high levels reached in late 2022. Despite elevated levels of volatility—driven by temporary setbacks in the fight against inflation and uncertainties around events such as the elections in the US and France—global bonds posted a second straight year of positive returns in 2024¹.

Today’s higher starting yields have materially improved the risk/return trade-off for fixed income. In this environment, more of a bond investor’s total returns come from coupon payments - which should also provide more of a cushion against losses if interest rates were to rise and bond prices fall.

We estimate an 88% probability that global bonds² will deliver positive total returns over the next year. The chances of investors earning negative total returns are greatly reduced, and would likely only result if yields were to rise substantially such that capital losses exceeded the increased income generated from higher coupon payments. This “coupon wall” means the income from bonds should be sufficiently large enough to protect investors against even modest increases in interest rates and their associated price declines, so that total returns remain positive.

Before the global hiking cycle began three years ago, low bond yields did not offer the same protection. Even more modest yield increases than what we experienced in 2022 would have pushed bond returns into negative territory.

An improved risk/reward environment for fixed income relative to before the global hiking cycle began

Probability of returns for global bonds: 2024 versus 2021

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Notes: The chart is based on the distribution of one-year-ahead price and income return projections from the Vanguard Capital Markets Model (VCMM) for the Bloomberg Global Aggregate Bond Index Sterling Hedged. The forecasts are sorted by positive price returns (interest rates fall) and two scenarios under negative price returns (interest rates rise) - income returns from coupons offset price losses and income returns do not offset price losses, leading to negative total returns. The bars indicate the proportion of simulations falling into each of these three buckets. 

Source: Vanguard calculations, based on data from Bloomberg as at 31 May 2021 and 8 November 2024.

IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Results from the model may vary with each use and over time.

Bonds: An all-weather asset class

Across developed markets, we expect long-term yields to remain elevated over the next decade as the era of sound money lives on – characterised by positive real interest rates and a higher neutral rate³ than during the 2010s. While this means we do not expect material price appreciation from falling yields, we do continue to expect solid income returns to support bonds globally.

Near-term risks to this view hinge on the balance of global growth and inflation dynamics. If a significant shock to demand with falling equity prices were to spur a return to monetary easing and declining rates, bonds should provide a hedge in diversified multi-asset portfolios.

Alternatively, if inflation were to resurface, we believe yields across the curve would likely rise and the correlation between equities and bonds would turn positive as investors demanded more compensation for increased uncertainty. For investors with sufficiently long time horizons, the coupon payments from bonds would eventually catch up and replenish any near-term capital losses so that any rise in yields would ultimately improve bonds’ total returns over the long term.

Getting the credit you deserve

Corporate credit spreads are currently near 20-year lows⁴, having tightened further in 2024. Near-term economic risks could lead to wider spreads, which would hurt credit investors; however, continued economic strength could keep spreads at these tightened levels for some time to come.

Despite compressed spreads, credit markets can continue to do well. While there’s limited room for spreads to narrow further, overall yields are high and the outlook for fundamentals remains positive.

We think corporate credit plays an important role in portfolios, given its premium over government bonds and low correlation with other assets. Overall, credit is expected to produce better returns than government bonds, with lower volatility than equities.

A strong outlook for fixed income

Looking ahead, the outlook for fixed income remains strong – bonds are still back. In the higher-rate environment that we believe is here to stay, we expect long-term bond returns to be closer to the levels seen in the early 2000s. However, more of a bond investor’s returns are likely to come from higher coupon payments that get reinvested at higher rates, than from price appreciation.

Our current return expectations for aggregate bonds, government bonds and credit are similar to our forecasts in last year’s Vanguard economic and market outlook. Over the next decade, we expect annualised returns for UK aggregate bonds and hedged, global ex-UK aggregate bonds to be around 4.8% and 5.0%, respectively, with slightly lower expected returns for UK and global government bonds (4.5% and 4.7%) and slightly higher expected returns for UK and global credit (5.3% and 5.4%) and emerging market sovereign bonds (5.6%), though with higher uncertainty.

10-year forecasted annualised returns for fixed income assets

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Notes: The forecast corresponds to the distribution of 10,000 VCMM simulations for 10-year annualised nominal returns in GBP for assets highlighted here. Median volatility is the 50th percentile of an asset class's distribution of annualised standard deviation of returns. The median 10-year annualised nominal return forecasts as at the end of last year are shown by the brown bars. Asset-class returns do not take into account management fees and expenses, nor do they reflect the effect of taxes. Returns do reflect the reinvestment of income and capital gains. Indices are unmanaged; therefore, direct investment is not possible. Benchmarks used for asset classes: UK agg. bonds: Bloomberg Sterling Aggregate Index; Global ex-UK agg. bonds: Bloomberg Global Aggregate ex-Sterling Index Sterling Hedged; UK Gilts: Bloomberg Sterling Gilts Total Return Index; Global government bonds: Bloomberg Global Treasury Index Sterling Hedged; UK credit: Bloomberg Sterling Aggregate—Credit Index; Global credit: Bloomberg Global Aggregate—Corporates Sterling Hedged; Emerging sovereign bonds: Bloomberg Emerging Markets USD Sovereign Bond Index—10% Country Capped Sterling Hedged.

Source: Vanguard calculations, based on data from Refinitiv, as at 8 November 2024.

IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Results from the model may vary with each use and over time.

¹ Based on the Bloomberg Global Aggregate Index Sterling Hedged, which returned 3.0% for the period 31 December 2023 to 31 December 2024.

² Global bonds are represented by the Bloomberg Global Aggregate Index Sterling Hedged. 

³ The neutral rate is the equilibrium rate at which no easing or tightening pressures are being placed on an economy or its financial markets.

⁴ In November 2024, the option-adjusted spreads (OAS) of the Bloomberg US Credit Index and the Bloomberg US Corporate High Yield Index tightened to levels last seen before 2008.