The greatest fixed income investment opportunity in decades?

Are you ready for a world where the 10‑year U.S. Treasury yield goes to 6%? According to our head of Global Fixed Income and CIO Arif Husain, this scenario—unthinkable just a few years ago—has become a real possibility in the next 18 months due to U.S. fiscal expansion and the potential for tariffs to drive inflation higher. 

Let’s explore why such a shift may occur, what the asset allocation implications are, and what strategies can help effectively navigate this landscape.

The path to higher bond yields—three key drivers

1. Fiscal concerns: The recently enacted “One Big Beautiful Bill” looks likely to keep the U.S. deficit elevated for at least the next two to three years, as stimulus is front‑loaded and spending cuts are back‑loaded. Consequently, fiscal concerns will persist, as the deficit must be financed through Treasury debt issuance. This will occur at a time when other developed markets also need to issue more government debt to finance deficits, creating competition for buyers and pressuring yields higher.
2. Upside inflation risks: The pass‑through to consumer prices from tariffs is likely to be greater than markets anticipate, driving inflation higher in the second half of this year. Blerina Uruçi, our chief U.S. economist, estimates that a 10% across‑the‑board tariff on U.S. imports would increase annual headline inflation by between 0.5 and 1.0 percentage point. With a 15% effective tariff rate, the inflation shock could be as high as 1.5 percentage points.
3. Global growth to hold up: While tariff policy may keep global growth below trend, a recession is unlikely. All three of the world’s largest economies—the U.S., the eurozone, and China—are fiscally expanding right now, which should be supportive. The effects may take time to feed through, however.

“From an asset allocation perspective, the potential implications are significant, as investors might not need to hold as much equity.”

The confluence of these three factors means that Treasury yields should go higher, with a 6% 10‑year yield in the next 18 months within the realm of possibility. The path to that level will be volatile. However, it’s worth highlighting how far the 10‑year Treasury yield has already moved. In March 2020, it was below 0.5%; now it’s comfortably above 4%—nearly nine times higher. With this context, a move to 5% or even 6% doesn’t seem so large. If it happens, we believe it would create a historic investment opportunity in fixed income, with meaningful implications for asset allocation. We think it’s crucial to begin planning now.

Potential implications

Generational opportunity in fixed income

The share of fixed income in asset allocation has been growing in recent years thanks to higher bond yields. A rise in the 10‑year yield to above 6% would amplify this trend as it would offer investors a generational opportunity to earn the most attractive income from bonds in decades. For example, the yield on the Bloomberg U.S. Aggregate Bond Index (Agg)—a widely used benchmark for U.S. investment‑grade bonds—would likely surpass 6% if the 10‑year yield rises to 6%, a level not seen since the early 2000s.

For perspective, the Agg averaged a yield of just above 2% between December 29, 2011, and December 31, 2021. During this period, investors were compelled to take on more risk in equity and alternative markets to help them meet their return goals. Although bond yields have risen in recent years, leading to investors adding back to fixed income, they still remain an underweight allocation for many. This dynamic could change if the 10‑year yield increases to 6% as sectors sensitive to Treasuries—such as investment grade and high yield—would also rise, offering investors the potential to earn more income from bond investing.

Less equity exposure needed to achieve return goals

From an asset allocation perspective, the potential implications are significant, as investors might not need to hold as much equity. For example, those seeking a return goal of, say, 7%, could hypothetically achieve this through a higher allocation to bonds, which are historically less volatile than equities. However, investors would be exposed to more duration1 risk if they increase their fixed income allocation.

Based on our five‑year capital market assumptions, if the only change in market valuations across asset classes was a 100‑basis‑point rise in U.S. Treasuries for all maturities, the projected annualized return would be around 6.5% for the next five years. Although this approach is simplistic, it is meant to illustrate that an increase in yields from current levels could lead to similar or even higher return expectations for bonds compared with stocks over the next five years. For U.S. investment‑grade corporate bonds, based on our five‑year capital assumptions, the expected return is 7% if Treasury yields were to increase by 100 basis points, while U.S. high yield bonds are forecast to return 7.5%. These equity‑like return levels would appeal to investors not only from a total return perspective, but also due to the stability of income as bonds are typically less volatile than stocks. Nonetheless, fundamental research remains crucial to reduce default risk.

“Navigating the rising yield path is as important as what to do when the destination is reached.” 

Considerations for navigating this evolving fixed income landscape

A higher fixed income allocation seems like an obvious choice if yields get to 6%, but what about the intervening period? Navigating the rising yield path is as important as what to do when the destination is reached.

In the insurance space, most portfolios are focused on income with the aim of maximizing their book yield, while some prioritize total returns, making it important to avoid drawdowns. Given our view that intermediate‑ and longer‑maturity bond yields are likely heading higher, we suggest that both types of portfolios focus on shorter maturities and consider reducing duration below their strategic duration target in the current environment. If yields get closer to 6%, consider adding longer maturities and possibly exceeding the strategic duration target. This approach may help mitigate drawdowns if yields go higher, which is particularly crucial for total return‑focused portfolios. Additionally, this strategy should provide opportunities for reinvestment at higher yields, which is important for income‑focused portfolios that are seeking to gain more yield.

Conclusion

We believe that a rise in the 10‑year Treasury yield to 6% would present a historic investment opportunity in fixed income with significant implications for asset allocation. Investors might not need as much equity or equity‑like exposure to achieve return goals in such a scenario as bonds could offer stock‑like returns with potentially less volatility. This doesn’t mean that investors should sit and wait for this big shift to happen—there are strategies they can consider now in preparation. This includes focusing on shorter maturities where yield levels are still appealing. Further out the curve, investors are not being compensated yet for the duration risk. But the closer yields move to 6%, longer maturities should start to become attractive again.