Vanguard Sees Select Bond Opportunities Amid Cautious Optimism on Yields

As the year draws to a close, Vanguard believes investors have a window of opportunity to secure solid long-term yields further out on the curve.

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With the Federal Reserve widely expected to continue easing policy, short-term yields are likely to drift lower. The Fed cut rates by 25 basis points in September and is set to meet again at the end of this month. According to the CME FedWatch Tool, futures markets are pricing in a 97% probability of another quarter-point rate cut, signaling strong market conviction that the central bank will stay on its path of gradual easing.

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At the same time, Vanguard cautions that investors must weigh both economic headwinds and tailwinds as they plan their portfolios.

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“The labor market is adjusting to a new equilibrium, while the effects of tariffs will continue to build into 2026, posing potential downside risks,” said Sara Devereux, global head of Vanguard’s fixed income group, in the firm’s latest quarterly outlook released Thursday.

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“Still, there are encouraging signs ahead that should foster a more supportive environment for growth and markets in the coming quarters,” she added.

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Vanguard estimates that roughly one-third of the tariff effects have already filtered through to consumers, with half expected to be felt by year-end. The rest, according to Devereux, will likely materialize over the course of next year.

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Despite ongoing challenges such as tariffs, inflation pressures, and broader economic uncertainty, valuations across fixed income remain elevated, noted Colleen Cunniffe, Vanguard’s head of global taxable credit research, in an interview with CNBC.

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However, she pointed out that corporate fundamentals remain healthy, providing a buffer against potential volatility.

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“While some indicators are backward-looking, we don’t currently see any meaningful cracks in the consumer sector or labor market that would suggest imminent weakness,” Cunniffe said.

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As a result, she describes her outlook for the bond market as “cautiously optimistic,” emphasizing the importance of security selection across various credit tiers to identify value opportunities.

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Within investment-grade corporate bonds, Cunniffe sees promising setups in companies with steady, predictable cash flows. Her strategy often involves looking “down the capital structure,” meaning targeting bonds that rank lower in repayment priority but offer higher yields in return.

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A sector she finds appealing is utilities, where strong fundamentals meet the potential for better returns.

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“You can find opportunities within the same company or industry by moving lower in the capital structure,” she explained. “That’s where investors can pick up extra yield without significantly changing their overall risk exposure.”

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Cunniffe also highlighted that this approach offers a measure of defensiveness, helping the portfolio hold up even if her cautiously optimistic outlook doesn’t fully play out.

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Beyond utilities, banks remain an attractive area within investment-grade credit. Vanguard cites solid asset quality, strong earnings performance, and upcoming regulatory relief as reasons to remain constructive on the sector.

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When it comes to high-yield bonds, Cunniffe said Vanguard is being more selective, choosing to “pick its spots” as opportunities arise. While valuations in this market segment are rich, overall credit quality has improved compared to historical norms.

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One trend that’s creating opportunities is the pickup in mergers and acquisitions activity, which has led to new high-yield issuances from companies spun off from investment-grade parents.

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“These spin-offs can be quite compelling,” Cunniffe noted. “You’re often getting a business that simply isn’t strategic for a larger corporation anymore but it’s still fundamentally sound. Because it’s newly independent, it’s being financed in the high-yield market.”

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Vanguard has also been expanding exposure to structured products to enhance portfolio income. This includes asset-backed securities (ABS) and collateralized loan obligations (CLOs) segments that can offer attractive spreads and diversification benefits.

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Meanwhile, emerging markets are presenting compelling value, particularly within the mid-quality tier, according to Cunniffe.

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“The mid-quality space in emerging markets looks the most attractive to us right now,” she said. “We’re avoiding some of the lower-quality oil exporters, where risks remain elevated.”

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As an example, she cited Mexico’s recent debt issuance as a favorable opportunity that Vanguard has recently taken advantage of.

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As 2025 approaches, Vanguard’s overall stance blends optimism with caution. The firm sees meaningful opportunities across the fixed income landscape from investment-grade corporates to structured products and select emerging market debt while remaining mindful of global risks.

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For investors willing to navigate the crosscurrents of policy shifts and economic realignment, the coming months could offer attractive entry points to lock in durable yields before the Fed’s expected rate cuts push them lower.

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