Over the summer, the Federal Reserve raised interest rates for the first time since 2023 under its new Chair, Kevin Warsh, and the 10-year Treasury yield climbed above 5% for the first time since 2007. As fixed income markets grapple with the effects of persistent inflation, ongoing geopolitical volatility and national debt approaching $40 trillion, bond prices have declined year-to-date. So, what’s really going on with the bond market?
It’s important to note at the outset that investors have lived through one of the most consequential shifts in fixed income markets in decades. In 2000, the 10-year Treasury yielded roughly 6.5%, and most people at the time might have felt like they were living in historically “normal” times considering they had seen higher 10-year yields for most of the previous three decades. What followed over the next two decades, however, were several “hundred-year floods” in the economy that drove rates dramatically lower. The Dot-Com market collapse from 2000 to 2002, the Global Financial Crisis from 2007 to 2009 and then the Covid pandemic prompted several years of zero rates and multiple rounds of quantitative easing, with the multi-decade fixed income bull market culminating in August 2020 with the 10-year Treasury yield near 0.5%.
While low fixed income yields were entrenched, bonds provided both income and “portfolio insurance”, paying a coupon and generally rallying when equities fell. However, that relationship started to break in 2022 when interest rates moved back up sharply towards historically normal levels. The Bloomberg U.S. Aggregate Bond Index lost roughly 13% in 2022, its worst calendar year on record, and stocks and bonds fell together.
Fast forward to 2026 and rates are once again meaningfully moving up. One of the key culprits for the significant rise in rates is that inflation has been above the Fed’s stated target for 65 consecutive months. Three primary forces are responsible for the more recent rise in rates:
- Policy: after the September Fed meeting, futures markets implied roughly three more quarter-point rate increases over the next year.
- Uncertainty: investors are again demanding extra compensation, known as the term premium, for lending to the government for longer periods when the paths of inflation and deficits are hard to forecast.
- Supply: the Treasury continues to finance large deficits, and companies building AI infrastructure are borrowing heavily in the same market.
For investors, rising yields cut both ways. In the short run, bond prices fall when yields rise, and that has weighed on fixed income returns this year. Over longer periods, however, the yield an investor starts with is historically the single best predictor of what a high-quality bond portfolio will earn, and the starting point right now is historically attractive. The broad investment-grade bond market now yields roughly 5.5%, enough that rates could rise by close to one full percentage point over the next year before a typical core bond portfolio would move into negative territory.
Looking ahead, the fourth quarter brings a crowded calendar. The Fed meets again on October 28, third-quarter earnings season begins in mid-October, voters go to the polls on November 3, and Congress faces a December 11 federal government funding deadline.Any of these could stir volatility in the bond market, as could a changing of tensions with Iran or reopening of the Strait of Hormuz. So far, midterm-year volatility has been muted in 2026, as strong earnings and AI investment overshadowed political uncertainty, and though that could change in the weeks ahead, we should not be surprised by a bumpier path into November.
The last several months have reinforced that investors continue to navigate markets shaped by resilient growth, elevated rates, persistent inflation concerns and unresolved geopolitical risks. The bond market’s recent volatility underscores that the path forward may remain uneven, but portfolios that emphasize thoughtful diversification with fixed income should be able to take advantage of meaningful income that higher yields offer going forward.
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