Surveying the Fixed-Income Landscape

The U.S. bond market declined 0.7% in May with Treasury securities posting their first negative month of 2025. While headlines focused on tariff turbulence, fiscal policy uncertainty and Moody’s credit rating downgrade, the underlying story reveals markets adapting to fundamental shifts that may reshape bond investing for years to come.

Resilience Through Volatility

The sweeping tariff announcements in early April triggered significant bond market volatility. By late May, 30-year Treasury bonds were yielding above 5% for the first time since 2023, though they began declining moderately in recent weeks.

But despite the downgrade and uncertainty, the Treasury market continues to be a destination for capital during periods of global and domestic stress. The U.S. remains highly rated (Aa1/AA+) and has the confidence of investors who can move large amounts of capital both into and out of the market with relative ease—so it’s still a destination for investors seeking quality and liquidity. In our view, any immediate weakness in the aftermath of the downgrade has more to do with other headlines (budget, deficits, tariffs) than a deep-rooted concern that Treasury bonds will miss either a principal or interest payment.

Judging by the market’s response, it appears as though some investors shrugged off the downgrade, in part because it was neither surprising nor revelatory. We don’t shrug when a bond issuer in our portfolios is downgraded, but we do continue to feel very comfortable and confident in our Treasury allocations and the purpose they serve in a portfolio.

The Policy Uncertainty Premium

Much of the recent rise in longer-term Treasury yields reflects an elevated “term premium”—the extra compensation investors demand for the level of risk over the life of a bond. This premium has reached decade highs, signaling genuine market concern about fiscal and trade policy trajectories.

The Trump administration’s proposed tax legislation could expand deficits by $3 trillion to $4 trillion over the next decade, while tariff policy remains fluid with average effective rates potentially rising into the high teens. This uncertainty supports our expectation of a steeper yield curve, with long-term yields remaining elevated relative to short-term rates.

The U.S. is averaging over 100,000 new jobs created every month. Combined with an inflation rate above the Fed’s 2% target, we believe the central bankers will keep rates steady throughout the summer. That said, consumer inflation expectations have risen—if those expectations become reality, it could constrain the Fed’s policymaking ability.

A Treasury Dynamic Worth Watching: Japan’s Structural Challenge

While broad fixed-income opportunities have improved, one development in Treasury markets warrants close attention: Japan’s growing need to reduce its $1.1 trillion Treasury position—the largest foreign holding of U.S. government debt.

Japan’s policymakers are under pressure to get their financial house in better order. Government debt at 235% of GDP combined with an aging population requiring domestic savings for retirement could disrupt the status quo. Rising interest rates in Japan could lead to a repatriation of assets out of Treasurys and into Japan’s sovereign bond market.

How did Japan’s Treasury position get so large? Over four decades, Japan has quietly recycled trade surpluses into Treasury purchases, effectively subsidizing American consumption. This arrangement helped both economies but created structural dependencies that are now unwinding.

We began to see this in August 2024, when the Bank of Japan (BoJ) raised interest rates and strengthened the yen against the dollar. Uncertainty arose over the “yen carry trade,” a longstanding practice of investors borrowing the lower-interest-rate yen to make investments in high-yielding assets abroad. If the BoJ continues tightening and the yen strengthens further (it’s increased nearly 8% in value against the dollar this year), we could see this strategy become less advantageous for investors.

This could result in higher rates in the Treasury market (and worldwide), which would raise borrowing costs for businesses and individuals, an obstacle to economic growth. It could also be a headwind for U.S. tech companies that have benefited from the yen carry trade.

The big question is if there will be a tipping point when investors dump Treasurys for Japanese government bonds en masse, causing yields to spike suddenly, or if it will be a slower process that gives markets and investors time to adjust. We are keeping a close eye on this dynamic and will adjust portfolios as necessary.

Current Opportunities Across Fixed Income

Despite volatility concerns, the broad fixed-income landscape has become fundamentally more attractive. Treasury yields around 4% to 5% now provide meaningful returns above inflation—a dramatic improvement from the zero-interest-rate era. The Bloomberg U.S. Aggregate Bond Index remains positive year-to-date, with the income generated by those higher yields offsetting price declines across sectors.

Investment-grade corporate bonds offer yields in the 5.2% range, while high-yield corporates provide approximately 7.5%—levels that could generate positive real returns over intermediate horizons. Municipal bonds present particularly compelling opportunities for higher-tax-bracket investors, with taxable-equivalent yields (TEY) of 5.40% to 5.59% for the top two federal brackets significantly exceeding comparable investment-grade alternatives. And when you factor in exemptions from state taxes (where applicable), that advantage grows even larger. For example, in Massachusetts, the home of RWA’s headquarters, the TEY ranges from 6.34% to 6.59%. In comparison, Apple bonds (Aaa/AA+) were trading around 4.87% at month-end.

We focus on short- and intermediate-maturity bonds as a general rule, given our belief that fixed income should function as a store of wealth for capital preservation and liquidity purposes in a portfolio. Considering the yields available, we urge clients to review their cash: Is yours accumulating in a bank account? Is it invested in certificates of deposit that are set to roll over into less attractive rates? Now could be a great time to add to your short- and intermediate-term bond portfolio and lock in higher yields, making your cash work harder for you.

Managing the Transition

We’re witnessing a fundamental shift from the extraordinary monetary policy support of the post-2008 period toward more market-driven pricing mechanisms. While this creates near-term volatility, it ultimately strengthens the investment case by restoring normal risk-return relationships.

The Treasury market is proving adaptable to these changes. April’s stress test demonstrated that enhanced market infrastructure and Fed implementation tools can maintain order even during significant volatility. The real question isn’t whether Treasury markets will remain volatile—they likely will—but whether current yield levels adequately compensate for these risks.

The evidence suggests they do. Real yields significantly above the pace of inflation restore the benefits investors historically receive for holding government debt. For clients seeking to balance income generation with portfolio stability, the current fixed-income environment offers opportunities not available since before the financial crisis in 2008. From Treasury securities to corporate bonds to municipal debt, yield levels now provide meaningful compensation for risk. The key is positioning appropriately across sectors for both the income benefits and the transition risks ahead while monitoring structural developments like Japan’s potential Treasury reallocation. We’ll continue to do just that.