Vanguard Gets Bullish on High-Quality Bonds

With three full quarters under its belt, the U.S. economy looks slow but still buoyant enough to avoid a recession this year, according to the latest report from Vanguard Group.

The report, which was published Oct. 23 with a focus on active fixed income strategies, cited the 5.2% third-quarter gain by the Bloomberg U.S. Aggregate Index as the second-best quarterly return since 1996, and suggested a coming end to the longest yield-curve inversion in U.S. history.

“In early September, the slope between 2-year and 10-year yields flipped positive for the first time since July 2022,” the report stated. “By the start of the fourth quarter, Treasury yields were priced for about 140 basis points of additional rate cuts over the next 12 months.”

The inverted yield curve during the start of a Fed cycle of lowering interest rates has been drawing attention to the so-called belly of the curve to 3- to 7-year bonds.

Municipal bonds also stood out in the quarter with a 2.7% return.

Yield Curve Reversion

The report recognized a “surprisingly robust September payrolls report that tempered expectations for further slowing in the economy.”

With the Fed in an interest rate-cutting cycle, while minding the inflation risk, Vanguard said, “we expect bonds to perform well in a range of economic scenarios and to act as a reliable ballast to equity volatility” that could lead up to the November presidential election.

This year through Oct. 21, the top performing non-leveraged fixed income ETF is the Folio Beyond Rising Rates ETF (RISR), with a gain of 17.7%, followed by the Rareview Dynamic Fixed Income ETF (RDFI), which has gained 15.3% this year.

But in terms of net asset flows this year, the leader is the iShares Core US Aggregate Bond ETF (AGG), which has taken in $16.4 billion in 2024, followed by the Vanguard Total Bond Market ETF (BND), which has taken in $13.3 billion.

As detailed in the Vanguard report, the ETF issuer is “set up to make the most of opportunities across credit sectors, but we’re more selective about lower-quality issuers that have greater sensitivity to economic weakness.”

“Historically, when economic growth has slowed but stayed positive, higher-quality fixed income has done well,” the report continued. “We’re sticking to that playbook for now.”

Based in Malvern, Pa., Vanguard is the second-largest ETF issuer with more than $2.6 trillion invested across 86 ETFs.