After a tough end to 2024, bond investors weathered a varied market landscape in 2025’s first quarter. Interest rates across the Treasury yield curve fell, especially in the two- to 10-year range, causing prices to rally. Meanwhile, credit spreads widened modestly from historically tight levels amid renewed concerns about the impact of tariffs and the potential for a recession. All told, core bond investors fared well. The Morningstar US Core Bond Index, a proxy for the US-dollar-denominated investment-grade bond market, gained 2.78% during the quarter.
While most fixed-income Morningstar Categories eked out positive returns, bond market volatility lingered. The year started off strong with riskier debt such as emerging-markets bonds outperforming corporate debt, however February brought growing uncertainty. The Federal Reserve kept its overnight borrowing rate for banks steady as it evaluated the impact of the policy changes, while the investors in turn adopted the time-tested flight-to-safety path. High-quality and long-duration bonds like Treasuries and agency mortgages led the way. The intermediate core bond funds, which invest in a mix of these high-quality bonds, on average gained 2.63% during the quarter.
While long government-bond funds led the way with a 4.42% average return, strong fundamentals and higher starting yields for most fixed-income sectors kept credit-sensitive assets, such as bank loans and high yield in positive territory. For the quarter, the bank-loan and high-yield bond funds returned 0.21% and 0.86% on average, respectively.
Global-bond funds, which struggled in 2024’s final quarter, gained 0.87% this quarter. The average fund in the unhedged global-bond category gained 2.68% as the US dollar weakened.
Below, we dig into a few fixed-income categories and highlight how some of our favorite bond managers fared during the quarter.
Inflation-Protected Bonds Came Roaring Back
Following a disappointing 2024 calendar-year return, rising inflation expectations and falling Treasury yields benefited inflation-protected bond funds, which gained 3.87% on average. The longer maturity portfolios comprising this category were more sensitive to the first quarter’s downward trajectory in rates following fears of economic slowdown.
The 4.71% return of Pimco Real Return PRRIX, which has a Morningstar Medalist Rating of Bronze, landed in the category’s top quartile. The fund’s overweight to US duration helped as yields fell especially across the longer end of the curve.
Bronze-rated BlackRock Inflation Protected Bond’s BPRIX 4.07% gain was in line with the return of its typical peer. The fund’s duration generally reflects the managers’ economic and inflationary outlooks, but it has stayed within one year of its Bloomberg US Treasury Inflation-Protected Securities Index. Its longer-than-average duration hurt returns in 2024’s last quarter when yields spiked, and its premature reduction of interest-rate sensitivity once again curbed gains this quarter as yields fell.
Emerging-Markets Bond Returns Climbed
A weakening US dollar during the first quarter provided a tailwind for investors who sought opportunities abroad. Emerging-markets bond local-currency funds, which invest more than 65% of their assets in foreign-currency bonds from developing countries, gained 4.02% on average while the norm for emerging-markets bond funds that hedge currency exposure back to the US dollar gained 2.42%.
Amid the weakening US dollar, managers with more appetite for certain foreign currencies fared well. Bronze-rated Pimco Emerging Markets Local Currency Bond’s PELBX 4.93% gain during the quarter beat 90% of its emerging-markets bond local-currency Morningstar Category peers. The fund’s above-average exposure to certain emerging-markets currencies such as the South African rand, Polish zolty, and the Mexican peso boosted its returns. The firm’s hard-currency emerging-markets debt offering—Bronze-rated Pimco Emerging Markets Bond Fund PEBIX with more than 95% exposure to the US dollar—gained 2.92% and landed in emerging-markets bond Morningstar Category’s top quartile, though it was less impressive than its local-currency counterpart.
Investment-Grade Credit Beats Junk-Rated Debt
The Morningstar US Corporate Bond Index, a proxy for investment-grade US-dollar-denominated corporate bonds, returned 2.35% during the quarter and outperformed its lower-quality counterparts. High-yield corporate bonds were at a disadvantage relative to their investment-grade counterparts because their credits spreads widened more, and their shorter durations also meant they benefited less from falling yields. The Morningstar US High Yield Bond Index gained just 1%.
Bronze-rated Fidelity Corporate Bond ETF FCOR, which invests heavily in BBB rated debt, placed in the top quartile of its corporate-bond peer group, which consists of funds that invest predominantly in investment-grade-rated corporate bonds. On the other hand, Bronze-rated Federated Hermes Corporate Bond Fund FDBIX trailed more than 80% of rivals, in large part because of the portfolio’s high-yield bond sleeve.
High-Yield Bonds Crawled Through the Quarter
High-yield bond funds stayed positive for the quarter, gaining 0.86% on average. The less credit risk a fund took in general, the better it did because higher-rated bonds returned more than their lower-rated counterparts. Gold-rated PGIM High Yield Fund’s PHYQX careful security selection spurred its 1.49% gain for the quarter, one of the category’s best showings, while Silver-rated Fidelity Advisor Capital and Income’s FIQTX aggressive stance resulted in bottom-quartile performance.