The compelling case for short-dated bonds

As we begin the final stretch of 2025, market conditions appear challenging. Inflation remains sticky across a range of economies, preventing major central banks from enacting rapid rate cuts to support GDP growth. Widespread concerns about the sustainability of government deficits have eroded confidence among bond investors, and these worries have manifested a rise in longer term yields. 

But we believe this complex picture is not without opportunities. Starting yields are currently so elevated – higher than at any point during the quantitative easing period – that even a cautious stance toward duration exposure can prove beneficial. 

In this article, we’ll explore how the structural forces affecting the global bond markets are helping to improve the prospects for short-dated credit. 

Macro challenges

The outlook for global growth, while still positive, has weakened across 2025. In the US, GDP forecasts have dipped from 2% to around 1.5% on the back of tariff-induced volatility and fiscal uncertainty. Germany looks like it will escape a recession thanks to its major new government spending package, but is only expected to achieve GDP growth of around 0.2% this year. The UK’s anticipated growth figure is around 1%. 

Inflation remains a challenge for developed economies. In the UK, headline and core inflation are hovering around 3.8% while the core figure in the US is 3.1%. Germany is doing the best here, with headline and core inflation at 2% and 2.7% respectively. In all three countries, the core figures are seen as too persistent to allow for substantial interest rates cuts, even as growth disappoints. Market participants now expect two cuts from the Federal Reserve by the end of the year, and no further easing from the European Central Bank or the Bank of England. 

Rising government spending is further complicating the picture. The US’s debt-to-GDP ratio is forecast to reach 130% or above by the end of the decade; in the UK, the figure is projected at around 110%. Budget deficits at this sort of scale – of over 5% – are not sustainable forever, and we expect further yield curve steepening as bond investors demand increasingly large term premiums. 

A steep ascent

Over the past 20 months, we’ve seen an acceleration in yield curve steepening as bond investors have adjusted their expectations in response to changes in public finances (see Exhibit 1). 30-year Gilt yields now sit at their highest level this century, eclipsing the highs reached amid the 1998 Russian financial crisis and the default of hedge fund Long-Term Capital Management. Proportionally similar increases can also be observed in US Treasuries and European government bonds.

In our view, this steepening in the long end of the curve is evidence that markets are beginning to adjust to the evolving fiscal plans of developed economies. This has important implications for bonds of all maturities, but especially for short-term credit – the front end of the curve now offers historically attractive yields without the capital loss risks associated with longer term yield rises. 

As a result of these changes in curve steepness, we’ve become more tolerant of interest rate duration in our credit portfolios. By contrast, we remain wary of credit spread duration. Global investment grade spreads are now tighter than they were just before the global financial crisis. We don’t have major concerns about default risk or earnings deterioration, but we feel spreads could widen over the remainder of this year, and we are therefore defensively positioned on spread duration.

Improving momentum for short-term debt 

Encouragingly for bond investors, all-in yields are now sitting at historic highs – higher than at any point during the quantitative easing period (2009 to 2021). This means that, across the yield curve, there is plenty of potential for investors of all stripes over the next few years. 

Shorter dated fixed income looks the most promising. For the BAML/ICE Global Investment Grade 1-5yr Index, for example, the starting yield a given investor buys at is the prime determinant of returns over the next three years. The duration of the index is currently 2.8 years. Now that curves are once again upward sloping, yield curve rolldown – that is, capital gains realised as bonds get closer to maturity and migrate down the yield curve – means that the index’s 3.84% yield implies a 4.86% annualised return for the next three years (see Exhibit 2).

Actively managed short-dated funds targeting higher yields, of around 5%, meanwhile, could expect annualised returns of around 6%. The risk-reward profile looks very solid when you consider the potential for volatility across markets and asset classes, stretched equity valuations, fiscal uncertainty and geopolitical tensions. 

Further, short-dated credit offers an attractive combination of risk and return. The BAML 1-3 year and 1-5 year IG corporate indices both sit on the efficient frontier, boasting strong Sharpe ratios relative to both cash and some longer duration bonds. 

The dangers of the long end 

We remain cautious when it comes to the longer end of yield curves. While we have modestly increased duration, we have done so selectively. Long-dated Gilts, for example, look excessively risky: the UK government faces complex fiscal challenges, and we’re also seeing a structural fall in long end demand from UK pension schemes, which have historically been key buyers of this debt. Many of these pension funds are entering buyouts, and their new owners are reassessing the “buyer at any price” role that the schemes have played previously.

A window for high quality debt

To conclude, we believe that the present fixed income environment – complex as it is – presents appealing opportunities for informed bond investors to pursue returns in high quality, low duration credit. 

We are cautious on credit spread duration, but take more of a neutral stance on total duration. We are expecting additional yield curve steepening, and see further rate cuts and modest spread widening as catalysts for adding more beta back into our portfolios. 

Important information: The views expressed represent the opinions of TwentyFour as at 28 October 2025, they may change, and may also not be shared by other members of the Vontobel Group. This article does NOT express any political views or endorsements, but rather aims to objectively analyse the economic factors and implications. The analysis is based on publicly available information as of the date above and is for informational purposes only and should not be construed as investment advice or a personal recommendation. 

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