Piton Webinar: Year-End 2025 Fixed Income Update and 2026 Outlook
- Jan 26
- 8 min read
Updated: Feb 18
Fixed income is back. After years of playing second fiddle to equities and even gold, bonds delivered their strongest annual performance since 2020, with core bond markets returning approximately 7%. In our latest year-end webinar, CIO Brian Lockwood examined how three Fed rate cuts, a 43-day government shutdown, and a historic shift in Fed priorities are reshaping the fixed income landscape as we move into 2026.
Here are the key developments we covered in our year-end update and outlook:
2025: A Vindication for Bond Investors
Let's address the elephant in the room: yes, equities have had three phenomenal years. But 2025 reminded investors why bonds still deserve a seat at the table. Core bond markets returned roughly 7%, while cash returned just 4-4.25%. That's 300 basis points of outperformance simply by moving out in duration and being strategic about credit quality.
This return is particularly significant when you consider the context. Fixed income hasn't had an easy decade, making 2025's performance a welcome validation for asset allocators who maintained bond exposure. The message is clear: bonds aren't just ballast for your portfolio; they're active contributors to returns when positioned correctly.
For investors who have been sitting in cash waiting for the perfect entry point, 2025 demonstrated the cost of that caution. While cash provided safety, intermediate bonds delivered meaningful excess returns without requiring investors to take excessive risk in the long end.
Takeaway: The 300 basis point pickup over cash validates the strategic role of bonds in diversified portfolios, and we expect this outperformance to continue into 2026.
The Fed's Divided Easing Cycle and the Steepening Story
After a nine-month pause, the Federal Reserve delivered three quarter-point rate cuts in the final four months of 2025, bringing the federal funds rate to 3.5-3.75% by December. But the December decision revealed significant internal divisions: a nine-to-three vote representing the most dissent since 2019.
This disagreement reflects genuine uncertainty about how close we are to a neutral rate and what the appropriate pace of easing should be. But here's what matters most for bond investors: it's not the cuts themselves but what they did to the yield curve.
We witnessed significant steepening throughout 2025:
The 2-year Treasury dropped 77 basis points
The 10-year fell 44 basis points
The 30-year bond actually rose 6 basis points
This dramatic divergence tells the real story of the year. Investors positioned in the long end underperformed broader markets substantially, while those in the front and intermediate parts of the curve captured the lion's share of returns. Mortgages and high-beta sectors performed well, but the yield curve dynamics were the dominant driver of relative performance.
For 2026, we believe this steepening trend could continue and potentially accelerate. The 2-year has already done most of the heavy lifting, falling more than 70 basis points in 2025. The opportunity now lies further out the curve.
When the Government Shuts Down, Markets Hold Their Breath
The 43-day government shutdown that disrupted Q4 2025 created an unusual situation: markets couldn't react to data because there was no data to react to. October CPI was missing entirely, along with other critical economic indicators.
Interestingly, this information vacuum may have actually reduced interest rate volatility. Without clear data signals, investors couldn't panic or adjust positions based on unexpected numbers. Markets were forced into a holding pattern.
When the shutdown ended and clean data finally emerged with the December non-farm payroll report, the results were revealing: job growth came in well below 100,000 with negative three-month trends. This softer labor data has become central to the Fed's thinking and supports their pivot away from inflation as the primary concern.
The shutdown inadvertently highlighted how data-dependent markets have become, and how much uncertainty can actually dampen volatility in the short term, even if it creates challenges for longer-term positioning.
The Fed's Focus Shifts from Inflation to Employment
Here's one of the most significant developments as we close out 2025: the Fed has fundamentally shifted its primary focus from inflation to the labor market. With headline inflation easing to 2.7% in December and approaching the Fed's comfort zone, deteriorating employment data has taken center stage.
Non-farm payrolls falling below 100,000 with negative three-month trends signals genuine labor market softening. This shift matters enormously for Fed policy in 2026. It provides the central bank with justification to continue the easing process, potentially two more cuts in the year ahead, even if inflation remains slightly above target.
We're also expecting new Fed leadership in 2026, which adds another layer of uncertainty to policy direction. But the current trajectory is clear: if employment continues weakening, the Fed has room to be accommodative without worrying that they're fueling inflation.
There's even a beneficial feedback loop at play: if the labor market softens enough, consumers will naturally pull back on spending, which should help bring inflation down further. The Fed appears to be positioning for exactly this scenario.
Emerging Markets Steal the Show, Munis Make a Comeback
While much attention focused on Treasury market dynamics, two other fixed income sectors delivered noteworthy performance in 2025.
Emerging markets debt was the standout performer, returning nearly 20% in total (12% in hard currency alone). The currency play added substantial value beyond the coupon income, making EM debt the best-performing fixed income sector of the year. For investors with appropriate risk tolerance and global diversification objectives, EM debt validated its role as a return enhancer.
Municipal bonds had a tale-of-two-halves year. A rough start gave way to recovery as the long end rallied to match intermediate performance, finishing near 4% for the year. But as we look toward 2026, we're being selective about muni exposure.
Our focus is on high-grade municipal bonds only: essential service revenue bonds and state general obligation bonds. There are political and geographic uncertainties affecting certain municipalities that warrant a quality-first approach. This isn't the environment to reach for yield in lower-rated munis. Stick with strong credits that can weather whatever fiscal challenges emerge.
Corporate Spreads: Too Tight for Comfort
One of the biggest surprises of 2025 was the corporate bond market's stability and strength. Spreads remained historically tight throughout the year, and the market didn't even flinch when $70 billion of supply hit in the first few days of 2026.
This resilience is impressive, but it's also a warning sign. When corporate spreads are this compressed, you're simply not getting paid enough for the credit risk you're taking. The risk-return tradeoff doesn't favor the sector at current valuations.
That's why we're moving underweight corporates and focusing on higher-quality, more defensive names within the sector. Yes, corporate bonds performed well in 2025 alongside roaring equity markets. But here's the reality: corporate spreads are closely correlated with stock market performance. The equity rally has lasted a long time, and at some point, that relationship will reverse.
We're patient. When spreads eventually widen (and they will), we'll have a much better opportunity to rotate back into corporates from government bonds. For now, we're being selective and defensive.
The 5-10 Year Sweet Spot: Where We're Positioning for 2026
Here's our clearest recommendation for investors heading into 2026: favor the five-to-ten-year duration range. This is where we see the best risk-adjusted return opportunities across the yield curve.
Why this positioning? The front end of the curve (that two-year area) already did the heavy work in 2025, falling more than 70 basis points. You've captured most of the easy gains there. Meanwhile, the long end faces headwinds from persistent budget deficits exceeding 6% of GDP and continued Treasury supply pressure.
The five-to-ten-year space offers a Goldilocks position: far enough out to capture meaningful total returns from both coupon income and price appreciation, but not so extended that you're vulnerable to deficit-driven selling pressure in the long end.
This positioning works across sectors. Treasuries, corporates, and municipals all offer attractive opportunities in this intermediate range. You get the benefit of moving out of cash (which is no longer king) while avoiding the risks of the aggregate bond market's long-end exposure.
In fact, many investors may not need an aggregate bond portfolio at all. The intermediate sector returned around 7% last year, just 25-30 basis points less than the aggregate market but with significantly less long-end risk. For what most investors use fixed income for (diversification, income, and capital preservation), the intermediate space delivers without the volatility.
Know What You Own: Practical Advice for 2026
As we navigate new Fed leadership, large budget deficits, and persistent inflation concerns in 2026, the most important thing is to understand exactly what you own in your fixed income allocation.
If you're invested in an ETF, mutual fund, or separately managed account, know the guidelines. Know the duration exposure. Know the credit quality parameters. The yield curve steepening we expect to continue will create winners and losers based on positioning, and you need to know which side of that trade you're on.
For clients who have been sitting in cash for an extended period, now is an opportune time to move into intermediate bonds. You're capturing yield before it potentially declines further with additional Fed cuts, and you're positioning for price appreciation if easing continues.
For clients currently holding aggregate bond portfolios, consider whether you really need that long-end exposure. Can you achieve your fixed income objectives with an intermediate strategy that offers similar returns with less risk? For many investors, the answer is yes.
The broader theme for 2026 is maintaining quality while being strategic about duration. Upgrade credit quality in a slowing growth environment, but maintain enough duration to benefit from the easing cycle. It's a balance between offense and defense: capturing opportunities where valuations are attractive while staying liquid and defensive in the core portfolio.
The Bottom Line: Bonds Are Doing Their Job
Fixed income delivered in 2025, providing strong returns, diversification benefits, and positioning for the next phase of the Fed cycle. With the central bank now in easing mode and potentially two more cuts ahead in 2026, the fundamental backdrop for bonds continues to improve.
Rate cuts support price appreciation on existing holdings, while still-attractive yield levels provide income and cushion against volatility. For patient investors who maintain appropriate duration and credit exposure, that's a powerful combination.
As we move through 2026, we'll be watching three critical factors: the pace of labor market deterioration, whether inflationary pressures from past policies begin to fade, and how Treasury supply-demand dynamics evolve at the long end. Each will create opportunities across different parts of the fixed income spectrum.
For now, the playbook is clear: favor the five-to-ten-year sweet spot, maintain quality over reaching for yield, and stay disciplined about credit exposure in a tight-spread environment. Fixed income is back. Make sure you're positioned to benefit.
Ready to dive deeper? Access the full Year-End 2025 Fixed Income webinar recording on our website for comprehensive analysis of market positioning, emerging opportunities, and strategic outlook for 2026.
Brian M. Lockwood, CFA, is Chief Investment Officer at Piton Investment Management.
For more information:
Email: info@pitonim.com
Website: www.pitonim.com
About Piton
Founded in 2015, Piton Investment Management provides highly customized fixed income portfolio solutions to RIAs, institutions, and direct clients. Piton leverages its extensive market experience and access to create and manage fixed income and structured product portfolios across an array of custodial managers and turnkey asset management programs. Piton's product suite ranges from highly liquid "cash management" portfolios to longer duration strategies as well as highly nuanced structured product portfolios.
This analysis is provided for educational purposes and does not constitute investment advice. Past performance does not guarantee future results. Consider your individual circumstances and consult with qualified professionals before making investment decisions.
Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of BloombergFinance L.P. and its affiliates (collectively "Bloomberg"). Bloomberg or Bloomberg's licensors own allproprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg's licensors approves orendorses this material, or guarantees the accuracy or completeness of any information herein, or makes anywarranty, express or implied, as to the results to be obtained therefrom, and, to the maximum extent allowed bylaw, neither shall have any liability or responsibility for injury or damages arising in connection therewith.
The Bloomberg U.S. Aggregate Bond Index.
Supporting notes at the date of recording.
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