Bond market rallied in the third quarter of 2025, with patience paying off
Bond investors saw meaningful gains last quarter as markets rose in response to shifting economic signals. The Fidelity Fixed Income team maintained a patient, disciplined stance throughout the year, and that approach was rewarded as conditions turned more favorable.
So, what changed? A wave of cautious optimism returned as concerns over trade and government policy eased. The biggest catalyst: the U.S. Federal Reserve’s (the Fed) first interest rate cut of 2025 in September. This move, combined with indications of potential future rate cuts, supported gains across fixed-income assets.
In this kind of environment, how you manage interest rate sensitivity, also known as duration, becomes especially important. Let’s take a closer look at what duration management is, why it matters, and how we are actively managing duration to navigate today’s shifting rate landscape.
Understanding duration management
Duration management is a strategy used in bond investing to manage interest rate risk. When interest rates go up, the value of existing bonds usually goes down. When rates fall, their value will usually rise. Duration measures how much a bond’s price is expected to go up or down as its yield changes. The higher, or longer the duration, the more the bond price is expected to move as the yield changes. The lower, or shorter the duration, the less the price will likely move as the yield changes. It’s important to note that other factors beyond duration can also affect the value of a bond. These include changes in credit quality, inflation expectations, liquidity conditions, and overall market sentiment.
While no one can predict the future direction of interest rates, examining the "duration" of each bond you own provides a good estimate of how sensitive your fixed income holdings are to a potential change in interest rates. Investment professionals rely on duration because it rolls up several bond characteristics (such as maturity date, coupon payments, etc.) into a single number that gives a good indication of how sensitive a bond's price is to interest rate changes.
Duration is expressed in terms of years, but it is not the same thing as a bond's maturity date. That said, the maturity date of a bond is one of the key components in figuring duration, as is the bond's coupon rate. In the case of a zero-coupon bond, the bond's remaining time to its maturity date is equal to its duration. When a coupon is added to the bond, however, the bond's duration number will always be less than the maturity date. The larger the coupon, the shorter the duration number becomes.
Generally, bonds with long maturities and low coupons have the longest durations. These bonds are more sensitive to a change in market interest rates and thus are generally more volatile in a changing rate environment. Conversely, bonds with shorter maturity dates or higher coupons will have shorter durations. Bonds with shorter durations are less sensitive to changing rates and thus are generally less volatile in a changing rate environment.1
Approach to our client’s accounts
Managing duration effectively is one of the most important tools we use to help balance risk and return in fixed income portfolios, especially in a market shaped by shifting interest rate expectations.
At Fidelity, our fixed income team typically keeps portfolio duration closely aligned with the benchmark. This helps minimize the impact of rate movements while maintaining a consistent risk profile. We may make very small tilts to help manage risk within our accounts and will rebalance accounts back to their targets based on market conditions, bonds maturing, cash flows, among other reasons. Always with the goal of keeping portfolios on track with their long-term objectives.
A duration-neutral strategy relative to a benchmark means that the portfolio manager constructs a portfolio with a weighted average duration that is the same as or close to the duration of the benchmark index. By doing so, the manager aims to neutralize the portfolio's exposure to interest rate movements in comparison to the benchmark. If interest rates rise or fall, the value of the portfolio is expected to change by a similar amount as the benchmark, assuming a parallel shift in the yield curve.
When interest rates are expected to decline, we may extend the duration and maturity of our portfolios. Longer-term bonds tend to be more sensitive to rate changes and can offer greater potential for price appreciation in a falling rate environment. In this case, extending duration is a way to position for potential upside. Conversely, when rates are expected to rise, we may shorten duration to help reduce volatility and limit downside risk.
Finding balance
In today’s evolving market landscape, our investment team remains focused on positioning portfolios to benefit from long-term opportunities, while staying agile enough to respond to short-term shifts.
When expectations rise around potential Fed rate cuts, we often look to extend duration. Why? Because when interest rates fall, longer-duration bonds typically see greater price appreciation. It’s a strategic move that can help capture value in a declining rate environment. But navigating monetary policy isn’t just about reacting to headlines.
The Fed emphasizes its data-driven approach to setting policy, but the reality is, the data it relies on can often be mixed, delayed, or incomplete. To build a more comprehensive view of the economy, the Fed supplements official government reports with insights from its 12 regional Reserve Banks and private-sector sources, such as payroll data providers. These additional inputs help fill in the gaps, offering valuable context. Still, they serve as complements, not substitutes, for the foundational government data that anchors the Fed’s decisions.
In managing duration, we look to strike a balance between conviction and flexibility. Our goal is to deliver strong returns at a level of risk that aligns with long-term objectives. But we also recognize that markets, and the data that drive them, can shift quickly. That’s why we maintain the flexibility to pivot when new information emerges, in an effort to ensure that our portfolios remain well-positioned across a variety of market environments.
What’s next for bonds
In the third quarter of 2025, the global economic cycle remained in expansion, weathering geopolitical and trade policy uncertainty, while corporate earnings remained resilient. The U.S. economic outlook continued to be mixed, with corporate profits and credit conditions improving, while other areas, most notably the labor market, showed signs of softening.
The past three months, fixed-income performance benefited from falling U.S. Treasury yields and tighter credit spreads across all major categories. The yield curve has steepened significantly over the past year – short-term U.S. Treasury rates have declined in line with the trajectory of Fed policy rates, while yields on longer-dated bonds have remained elevated. Ongoing concerns about sticky inflation, rising deficits and Fed independence could keep long-term interest rates relatively high for some time.
In this dynamic market environment, we continue to find pockets of value, based on our view of pricing and fundamentals. Our goal remains to work with our experienced investment teams to try to find attractively priced bonds for the portfolio while maintaining a disciplined approach to risk management. We remain focused on the long term and follow a process that is analytical, logical and grounded in empirical data.
It is important to reiterate that the portfolio is constructed with a careful and intentional emphasis on security selection, especially with consideration to liquidity and financial resiliency. Investing is a long-term endeavor, and we’re focused on generating strong risk-adjusted performance over a full market cycle through our disciplined, risk-aware approach.