The year 2025 was, obviously, exceptionally atypical. Yet despite the plethora of challenges and concerns, be it the fiscal health of the federal government, periods of extreme volatility, the on and off again tariff policies, or the assortment of geopolitical shocks, the U.S. bond market delivered a better than typical year. The U.S. Aggregate Bond Index printed a total return of 7.2%, which is above the long-term average and good for the 73rd percentile of returns over the last 30 years.

Zooming out and taking the year as a whole, it might appear that the asset class performed exactly as designed: providing income and a degree of portfolio diversification without any drama. But under the hood we know it was a hard-won year of returns as existential concerns lingered around the global role of the U.S .dollar, foreign investor participation in U.S. Treasury markets, and the mounting cost of large budget deficits and debt levels.

Looking ahead to 2026, the outlook remains constructive. Attractive starting yields should provide a strong income baseline, credit market indicators remain very healthy, and a smaller federal budget deficit along with declining interest rate volatility are also supportive features. This article explores some key highlights from 2025, as well as a snapshot of rate expectations for 2026.

Final performance

For the full year 2025, performance (on a total return basis) was led by convertible bonds, driven by strong equity markets. High yield corporates and the U.S. Aggregate Bond Index also delivered strong high-single digit returns while long-term Treasuries lagged although still produced a solid 4.25% return thanks to the highest starting yields in 18 years.

The yield curve steepened as the Federal Reserve cut rates and inflation moderated

The U.S. Treasury yield curve “bull steepened” in 2025, which is to say shorter term yields fell more than longer-term yields. To be precise, the 2-year yield dropped 0.77%, the 10-year dropped 0.40%, and 30-year yields rose 0.06%. This reaction in the yield curve is driven mainly by two components: the Federal Reserve cutting interest rates (affecting shorter term rates) and moderating inflation (affecting medium term rates). The longest end of the curve, the 30-year Treasury, is often more of a reflection of the very long-run growth and inflation outlook in addition to long-run structural questions like the stability of the U.S. government and the safe-haven status of the U.S. dollar. With the benefit of hindsight and a year full of data, the evolution of the U.S. yield curve appears broadly consistent with these dynamics.

Treasury volatility declined for the third consecutive year

The MOVE Index, a measure of Treasury bond volatility, was a one-way street in 2025. Excluding the surge in volatility in April, amid the imposition of “Liberation Day” tariffs, the last 12 months continued the trend of easing volatility. Perhaps surprisingly, the index is now well below the 20-year average and within sight of the 20-year low.

A point of observation: three consecutive years of a declining MOVE Index is actually a normal occurrence after a surge in volatility (like what we saw in 2022). Over the last 30 years, there are three instances of multi-year easing in the MOVE Index: 2002-06, 2009-13, and 2022-present. Each followed a period of heightened volatility and the MOVE Index ended at a lower level each time.

Other Items of Interest

December FOMC Dot Plot

For the first time in several meetings, the FOMC Dot Plot update was uneventful. The December plot remained largely in line with September. There were a couple of marginal adjustments, but the net result was no change to the median annual estimate of the Federal Funds rate – that is, a projection for just one rate cut in 2026.

The market remains ahead of the FOMC on rate cuts in 2026

In contrast with the Federal Reserve’s projections, market pricing implies a 75% probability of at least two rate cuts in 2026. The median is for two cuts, but notably the distribution of outcomes is skewed to the downside (i.e., more cuts). While these probabilities will certainly change throughout the year, it is an informative point-in-time view on the market positioning for lower rates in 2026. This highlights a key risk to the 2026 outlook: the potential for the Federal Reserve to provide less monetary stimulus than anticipated.

Update on FOMC Chairman Nomination

Back in July, when we first reviewed the upcoming succession of FOMC Chair Jerome Powell, the race looked wide open with as many as five legitimate contenders. Fast forward to January and it now appears to be a two-horse race. Kevin Hassett and Kevin Warsh have catapulted to the front of the pack, at least according to prediction market pricing. Christopher Waller, once a front runner, is now a distant third. What is interesting about the last month is that in early December, President Trump had reportedly selected his nominee, but declined to reveal the name. No subsequent announcement has been made, suggesting the decision is still not final. A potential twist is that Trump wants Treasury Secretary Scott Bessent to take the seat, but Bessent has stated he doesn’t want the job, and perhaps the two remain in ‘negotiations.’ In conclusion, the succession remains quite uncertain. A decision is expected in January, but it wouldn’t surprise this Investment Team if there is another shoe yet to fall.