Using Bonds Wisely in a Bull Market for Equities

MIKE TOWNSEND: Bonds, generally speaking, have had a good 2025 so far. The Bloomberg U.S. Aggregate Bond Index, often just referred to as "the Agg," was up about 8.2% year to date as November began. 

But of course stocks have done better—the S&P 500^® was up about 16.5% year to date as the calendar flipped to November. It has hit all-time record highs 32 times so far this year. 

That's not surprising, of course. Bonds are supposed to be the more stable part of an investor's portfolio, less prone to big swings. And 2025 has been a good reminder of that. The S&P 500 may be up more than 16% year to date, but that also included a 19% drawdown in April. The bond index hasn't had anywhere near that kind of movement. It's been doing exactly what it is supposed to do amidst equity market volatility—provide some stability. 

Last weekend in The Wall Street Journal, longtime investing columnist Jason's Zweig wrote his weekly column with the provocative headline "Should You Just Buy Stocks Until You Die?" In it, he cited recent research by three academics who analyzed more than 130 years of stock market data from around the globe and concluded that investing completely in stocks—one-third domestic, two-thirds international—performed better over time than a portfolio with any bonds at all. The paper challenged two long-held assumptions of investing, that investors should own a mix of stocks and bonds and that one's portfolio mix should get heavier in bonds the older the investor gets. 

But even the researchers acknowledged that their plan was incredibly risky, and Zweig himself said in the column that he owns bonds, will continue to own bonds, and suggests that all investors should own bonds. Because historical research is just that, history. And we all know that past performance is no guarantee of future results. 

But in a market where it seems like equities just keep winning, it's a question a lot of investors are probably thinking about: "Why do I own bonds again?" 

Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to. In a little while, I'm going to be joined by Collin Martin, managing director and head of fixed income research and strategy here at Schwab, to talk about whether bonds still matter in an environment where the stock market just seems unable to stop going up. We're also going to dive into the big takeaways from last week's monetary policy meeting at the Federal Reserve, how the lack of data is making it increasingly difficult to get a read on the economy, and where fixed income investors should be looking for opportunities right now. 

But first, here's a brief update on the state of play in Washington, where the government shutdown is into its second month. 

There's no question that pressure is increasing on senators to find a resolution to the shutdown, which is now the longest in history. Federal employees missed a partial paycheck and a full paycheck in October and will miss a second full paycheck that is supposed to be paid out at the end of this week. While the administration has found workarounds to pay military personnel during the shutdown, it's not clear how much longer that can continue. 

November 1 saw benefits run out for the Supplemental Nutrition Assistance Program, or SNAP. That's the program that provides food stamps and other aid to about 42 million low-income Americans. A court ordered the administration to use supplemental funds to pay those benefits. The Agriculture Department said it would use about $5 billion in emergency funds to pay partial SNAP benefits this month, but that's well short of the more than $8 billion needed to cover full benefits for the month. 

November 1 also saw the start of the open enrollment period for purchasing health insurance through the Affordable Care Act. That's become one of the key flashpoints of the stalemate on Capitol Hill. As Democrats want to extend enhanced subsidies that help lower premiums for as many as 22 million people. Those subsidies are set to expire at the end of this year, so people logging into the system to renew their health care insurance for 2026 are seeing significantly higher premiums. Democrats have insisted that an extension of the subsidies must be part of any agreement to reopen the government. Republicans have held to their position that discussion of that issue can only come once the government has reopened.

And perhaps the biggest pressure point of all is increasing delays at airports, where air traffic controllers and TSA agents have been staging sick-outs as a protest against being forced to work without pay. That's led to flight delays and huge security lines. With the Thanksgiving holiday travel period now less than three weeks away, public frustration is putting pressure on both sides to find a resolution.

As a result, bipartisan discussions in the Senate about finding a compromise and ending the shutdown have picked up steam over the last week. Those discussions have remained behind the scenes and have not yet involved leaders of either party or the president, who is ultimately going to have to bless any deal. A quick resolution is far from a slam dunk, but there's a growing sense on both sides of the aisle that the shutdown has become unsustainable. We'll see.

I've also got my eye on one other issue, and that's a pretty significant case at the Supreme Court. The justices are wrestling with the legality of the bulk of the president's tariffs. Oral arguments were held yesterday in the case, which hinges on the legality of the president's use of emergency authority to impose his reciprocal tariffs on about 100 countries, as well as some of the tariffs on imports from Canada, China, and Mexico. The U.S. Court of International Trade ruled in May that the president exceeded his authority in imposing the tariffs under the International Emergency Economic Powers Act, known as IEEPA. An appeals court upheld that ruling in August but kept the tariffs in place pending the appeal to the Supreme Court. Now that case has finally been heard by the highest court. 

Both sides have asked for an expedited ruling, but there's no specific timetable for when the court will rule on the case. Some court experts have suggested that the beginning of December is about the earliest we could expect a decision, but even that is just a guess.

It's important to remember that the case is about the mechanism by which the president imposed tariffs, not about the overall merits of tariffs themselves. And even if the court rules against the administration, there are other ways that the president can impose tariffs, including a different emergency power that would allow tariffs of up to 15% for 150 days. And there's a regular process for imposing tariffs that involves the administration doing a study of the situation, publishing a report with findings, allowing for public feedback, and other steps. That's how the administration has imposed sector specific tariffs on steel, aluminum, copper, cars, pharmaceuticals, furniture, and other products. Those are not being challenged and will not be affected by the Supreme Court decision. 

Nevertheless, the case is being closely watched for the clarity it should provide for how tariffs can be implemented in the future.

On my deeper dive today, I want to focus on last week's Fed meeting and the difficult spot the Fed finds itself in for a variety of reasons, from worrisome signs in the economy to a lack of government economic data to personnel uncertainties and what it all means for the economy, for the bond market, and for ordinary people who are just looking to borrow for a home or a car at reasonable rates.

To help me do that, I'm pleased to welcome back to the podcast Collin Martin, managing director and head of fixed income research and strategy at the Schwab Center for Financial Research. Collin's been with Schwab for more than 13 years and holds the Chartered Financial Analyst designation. Collin, thanks so much for joining me today.

COLLIN MARTIN: You're welcome. Thank you so much for having me back.

MIKE: Well, Collin, the Fed has been doing a good job of communicating its plans. Even with a lack of data, the expectations were clear that we would see a 25-basis-point interest rate cut last week, and that's exactly what we got. But I'm always more interested in what is said during the press conference after the meeting. And Chair Jerome Powell did not disappoint. He had one of those split screen moments where the financial networks were showing the news conference live and watching the markets react in real time.

And when he said a further reduction in the policy rate at the December meeting is not a foregone conclusion, far from it, well, the market was, shall we say, a bit disappointed. The markets have been pricing in another cut in December, though expectations of that are much lower now than they were before Powell's comments. And the market seems to be still expecting more cuts throughout 2026, possibly to take the rate down to 3%, or around that level. So first, is that a reasonable expectation in your view? And what if the market doesn't get as much as it's currently anticipating?

COLLIN: We don't think that's reasonable right now—the idea of the Fed needing to take the rate to 3% or lower next year—just because we think the outlook is so uncertain. And apologies in advance, I'm going to use the term "uncertain" a lot right now, but we just think uncertainty is really high. And heading into last week's meeting, we didn't expect the Fed to cut as many times as the markets were pricing in before the meeting, that 3% or less level that you're talking about.

And that continues to be our view today. The implied probability of a cut in December was more than 90% prior to last week's meeting, assuming they cut last week. Right now, it's closer to 60 or 70%. So the likelihood of a cut next month is a lot lower than it was just a week or a week and a half ago. That sounds right to us, but maybe even a little bit high. We think the bar to warrant a cut is higher than a lot of people probably expect. 

We knew there was a somewhat uncertain outlook if we just look back to the previous Fed meeting in September where we got the updated dot plot. And that's where each Federal Reserve official participant puts a projection of where they expect the fed funds rate to be at the end of the next few years. And for 2025 specifically, there was this really wide range of views. And Powell confirmed that in his press conference. As you said, Mike, he said a cut in December is not a foregone conclusion. And he said there were strongly differing views from committee members about what the future path of policy looks like, specifically in December. 

Now I've heard from former Fed officials that, when we look at each meeting, most participants have pretty much made it clear what their outlook is and how they plan on voting before the meeting even starts. They kind of circulate that within the other participants. And then at the meeting, they kind of lay out the case for the next meeting, hoping to influence the other members. And I think what Powell is saying is that there's clearly just a lot of different views about what people are saying should be done next month. Now, also what was pretty important at last week's meeting were the two dissents.

One was from Governor Stephen Miran, who preferred a larger cut, and one was from Kansas City Fed President Schmid, who preferred no cut at all, which is pretty interesting. You don't see that too often where one person dissents or disagrees with the decision in favor of more cuts and someone else disagreeing in favor of fewer cuts. And then on top of the dissent from Kansas City Fed President Schmid, who suggested they shouldn't cut at all, we heard from Dallas Fed President Lorie Logan and Cleveland Fed President Beth Hammack that they agreed with him and disagreed with the cut last week. And that's going to be very important as we look into 2026, because they weren't voters this year, but they're going to be voters next year.

MIKE: Yeah, pretty interesting dynamics at the Fed, and I expect those dynamics are going to continue to be complicated as we head into the end of the year and into next year. But the goal, of course, of cutting the fed funds rate is to make it easier for businesses to borrow, and spend, and grow, and create more jobs to handle that growth. But we know the Fed's in a really tricky spot here.

It's really trying to balance two competing pressures, a weakening job market and sticky inflation that keeps creeping up a bit. Last week we saw some high-profile layoff announcements—14,000 at Amazon, 48,000 at UPS. In the context of the total number of employees these big companies have, these aren't that significant, but they're still large headline-grabbing numbers.

And by way of illustration, Nvidia, which last week became the first company to exceed $5 trillion in value, Nvidia has fewer than 40,000 employees all by itself. Clearly the Fed in its dual mandate is leaning towards the job side of the equation. But Collin, what are the risks of doing that?

COLLIN: The risk would be that the labor market isn't weakening as much as some of the indicators suggest right now. And also, we don't have some key labor market reports right now. We don't have the most recent non-farm payrolls data or the unemployment rate, given the government shutdown. So we, and the Fed, don't really have a full picture. Now, on the one hand, you mentioned those pretty large layoff announcements, which at a headline level seem pretty high.

But we saw headlines like those back in 2022 and 2023, and it didn't necessarily translate to a significant deterioration in the labor market. Maybe this time will be different, but we kind of saw that scare a couple of years ago. We didn't necessarily see a surge in the unemployment rate. 

Now on the non-farm payrolls data, a slowdown in hiring is to be expected when you're this late in the cycle. Now we saw the slowdown over the summer where we got a lot of negative revisions, and clearly, we're seeing fewer job gains each month. But remember, Mike, we're five plus years since the last recession. And the total number of employees on non-farm payrolls is near its all-time high right now. So a slowdown is to be expected as the economy matures. And if we look at the unemployment rate, it's still just 4.3%. That's low by historical standards. If we take a step back and look over the past 40 or 50 years, it's pretty rare that we see a number this low. So yes, it's up from the recent lows of 2023, 2024, but in the big picture, it doesn't look too concerning just yet. There's also a question of how much that's driven by immigration policies. And there are also some thoughts that the layoffs could be AI related. I think it'll take some time for us to get a better understanding of that. 

But if it is AI related, that's not something that lower interest rates can necessarily fix. And what I mean by that is, if you're a business and you're seeing productivity because of AI, you don't need certain employees anymore. If you now have a lower borrowing cost, is that going to change your outlook there? We're not sure it will. 

And then tying this all together, in his press conference, Powell said that for some part of the committee, it's time to maybe take a step back and see if whether there really are downside risks to the labor market or see whether, in fact, that the stronger growth that we're seeing is real. I think what he means by that is the strong growth we've seen, in terms of GDP, the revisions to second-quarter GDP showed a pretty strong and resilient and growing economy. I think there's the risks that, OK, the labor market's cooling, but it's not deteriorating significantly, and should we take signals from other parts of the economy? So this is the risk that, if the economy is doing OK, and the Fed cuts rates into that environment, does that result in a pickup in spending, strengthen the economy even more, and then maybe push inflation even higher down the road?

MIKE: Yeah, the inflation piece, of course, is the other side of the Fed's dual mandate. Fed has a different set of concerns there. Powell in his comments last week mentioned tariffs and that inflation would probably be closer to the Fed's 2% target if the tariffs were not in place. Many economists believe that we haven't really seen tariffs make their way into the economy, into prices yet. So if inflation starts to move up more rapidly, will the Fed be pushed to reverse course and even consider raising rates? And for bond investors, do you have any sense that there's a bit of a wait and see attitude, maybe hold off and see how things evolve on the inflation front over the next, say, three to six months?

COLLIN: We don't think the Fed will reverse course and raise rates anytime soon. We think the wait-and-see approach is more appropriate. If we look specifically at inflation, yes, it's sticky. Yes, it's above the Fed's 2% target, but it doesn't look like it's set to really reaccelerate from here. It's been holding in that 2.5% to 3% range for a while now. Now on the idea of tariffs, tariffs can raise prices, but generally, prices go up once to factor in that tariff and then hold to that level. They don't continue to go up. So for example, they don't keep going up each year because of a steady tariff. It's usually some sort of one-time price increase. Now, it's possible though that importing companies may have only passed through part of the tariffs, and they could pass through more down the road. It remains to be seen how it really plays out.

Now, if tariffs do raise prices, and if it results in slightly higher inflation over the short run, I don't think there's much the Fed can do about that. That's really a trade policy issue, not really a monetary policy issue. And we think this is a key reason why the Fed will take more of a wait-and-see approach right now. The labor market is cooling but not deteriorating significantly. Inflation remains elevated but isn't showing signs of surging. And economic growth is still at or above trend. So in our view, monetary policy seems to be in a pretty good place.

MIKE: The other aspect of the Fed meeting that's been getting a lot of attention, of course, is the lack of reliable government economic data as a result of the government shutdown. We did not get any jobs numbers for September. We won't get them for October. At this point, I think it's unlikely we'll have good jobs data until the end of the year, possibly even the very beginning of 2026. We've also not been getting weekly jobless claims data. Haven't been getting things like housing starts and retail sales.

We did get the September CPI number. That's an important inflation metric, but that was kind of a one-off. The law required that the Bureau of Labor Statistics collect that information and publish that information because it related to the cost of living increase in Social Security. But the White House has already said that they're not going to publish October CPI data. So how do you think that is impacting the Fed's decision-making?

COLLIN: Powell talked about this in his press conference, where he himself said that this could be an argument in favor of caution. And he used an analogy where he said it can be like driving in the fog. And if you're driving in the fog, what do you do? You slow down. So I think that's kind of the approach that that Powell and other Fed officials have right now. Yes, we're missing a lot of data. We still don't have that September jobs report. We probably won't get the October jobs or CPI reports.

But there are alternative measures out there, specifically from the various Federal Reserve District Banks. Some have even begun reporting these alternative measures. The Chicago Fed began publishing its real-time forecast of the unemployment rate. So there are other measures out there. And Powell did say that with the alternative measures they have, if there were a significant or material change in the direction of the economy, they'd probably pick it up. So yes, it's not good that we don't have the data, but it seems like they have enough tools. They have enough alternative measures that they think they'll have an idea of if there is a shift in their outlook. But with the mandates somewhat in tension, meaning the labor market mandate and the inflation mandate somewhat in tension, a cautious approach likely makes a lot of sense right now, since there really are risks to both sides. If you cut too much, inflation may reaccelerate. If you cut rates too little, maybe the labor market weakens more than expected. When the Fed sets its policy rate, it's trying to find the balance between its mandates, maximum employment and price stability. So the committee will look at all the data they have, official or alternative measures, to see if their policy rate will help achieve those outcomes.

MIKE: What about the bond market more broadly? Is it concerned about the lack of data? And maybe a related question: Does the bond market have the ability to push Congress and the White House toward a government shutdown resolution? I'm thinking kind of like the bond market's sort of temporary volatility really pushed President Trump to pause the tariffs back in April. So it did have this kind of influential voice on a policy at that time. I'm wondering if that can happen again.

COLLIN: On the lack of data, the bond market does not seem to be too concerned. There's been plenty of headlines since the government shutdown began, plenty of earnings reports that have continued to drive stock prices higher, albeit with some volatility here and there. But with the bond market, what really drives Treasury yields is the big-picture economic outlook, the inflation outlook, the labor market outlook. And we haven't really had those key indicators, so it's kind of kept yields in a pretty tight range, and it hasn't really shifted the narrative. Now, we did see a slight change because of the Fed meeting, but we're not getting those weekly releases that can change the outlook in real time. The stability we've seen, that can be good or bad. A stable bond market, I think you could argue, is generally a good thing. But the downside right now is that this could result in large swings down the road once we get the updated data. So for example, let's say we get data that suggests the labor market stopped cooling, and it actually was stable for the past few months. The bond market might readjust pretty quickly, and we'd probably see Fed-rate-cut expectations shift where the markets would probably price in fewer rate cuts. And you'd probably see long-term and even intermediate and short-term yields, as well, rise a little bit. So it can lead to surprises, up or down, the longer the shutdown goes on and then depending on what the data finally tells us once it's released. 

On the idea of the bond market pushing Congress or the administration, we don't really see much there. Long-term yields, we know, is something that the administration is looking at. They're very well-behaved right now, at 10-year Treasury yield, just over 4%. If it were to rise significantly, maybe the administration might want to speak with members of Congress to try to come up with some sort of resolution. But right now, the bond market isn't showing anything that would suggest that Congress or the White House needs to act quickly. One thing that usually gets the government's attention as it relates to the Treasury market is the debt ceiling, but that was taken care of with the passing of the One Big Beautiful Bill Act, which raised the debt ceiling by 5 trillion. So that's really not on anyone's radar right now.

MIKE: I want to come back to the debt question in just a minute, but sticking with the fed funds rate for now, whenever it comes out, it sets off a flurry of articles talking about what it will mean for things like car loans and mortgages. And that kind of focus always feels confusing to me because the fact is there isn't really a one-to-one relationship between the Fed cutting interest rates and the rates suddenly falling for car loans or mortgages. Mortgage rates continue to be well above 6% on average. So how far would the Fed rate have to fall in order to make a meaningful difference for mortgage rates?

COLLIN: Well, as you mentioned, there isn't a one-for-one relationship between the fed funds rate and mortgage rate. The fed funds rate is a very short-term rate. It's an overnight rate, and mortgage rates tend to be 30 years. So they're more based on expectations of the economy, growth, inflation, things like that. There's an indirect relationship, but not a one-for-one. So maybe the question is, how much do mortgage rates need to fall to make a meaningful difference for potential home buyers as opposed to how much does the fed funds rate need to fall. Now for many home purchases, there's a buyer and a seller. There's always a seller, but it might be a builder or something like that. But for existing home sales, there's two sides to that transaction, where mortgage rates will probably make sense for both parties. And so we want to see not just where our rates are now relative to the past six or 12 months, but the past handful of years.

If we look at data from Freddie Mac, average mortgage rates were around 6.2% at the end of October. You alluded to that, Mike. That's down from roughly 7% at the start of the year. That seems good. That should make it more affordable relative to where we were at the beginning of the year. But we can also break down what existing homeowners are paying on their existing rates because that matters as well if you're thinking about selling your house or refinancing your mortgage.

And we can look at data from the Federal Housing Finance Authority, and just 20% of all outstanding mortgages have rates of 6% or more. We can look at the flip side. That means 80% of all mortgages have rates of less than 6%. So even though we've seen an improvement from 7% earlier in the year to just over 6% now, most mortgages are below that level. So there's not as much incentive for a seller right now or for someone looking to refinance their home. And to take it one step further, we can use that same data from the Federal Housing Finance Authority, and 50% of all mortgages have rates of 4% or less. So that means we need to see mortgage rates fall a lot from here, probably, you know, two percentage points or so for it to make economic sense for someone to refinance or sell. So something to consider and just something to be cognizant of when you hear about the potential for Fed rate cuts—it doesn't mean that that's going to translate to all borrowing costs like mortgage rates.

MIKE: Talking about mortgages puts me in the mind of mortgage-backed securities, which, of course, during the 2008 financial crisis, got a very bad reputation, and people really shied away from them. But those concerns are now gone. So for fixed income investors, are mortgage-backed bonds something to consider? And I'm guessing they aren't all created equal. So how do you go about choosing?

COLLIN: We do think there's something to consider, but before I get in, we just talked about mortgage rates and what that means for potential home buyers, and now we're talking about it from the investment side of the equation. So when we talk about Treasury yields and interest rates and borrowing costs rising and falling, it cuts both ways. Lower rates are good if you're looking to borrow, but if you're looking to invest and earn higher income, you kind of want to see yields stay relatively elevated. 

But on the idea of mortgage-backed securities, we do think they can make sense right now. There's probably a stigma from them, Mike, from the financial crisis, but we think there's an opportunity there mainly because they have relatively attractive yields. If we look at an index of agency-backed, mortgage-backed securities, so the Bloomberg U.S. MBS Index, they have average yields in the 4.5% to 5% area. I think that's relatively attractive. There's a lot of nuances though. They're very different from a traditional bond in that when you buy a traditional bond, there is usually a stated maturity date where you expect to get your money back, and you get, usually, your semiannual interest payments. It's very different with mortgage-backed securities because think of how it works if you're a homeowner paying your mortgage. You make a monthly payment, and in that monthly payment, it usually consists of both interest and principal. That's how mortgage-backed securities holders receive their money. So each month, you tend to get monthly interest payments, and it's a mix of interest and principal. Some of it goes to the mortgage servicers, but a lot of it flows to the end investors. 

Now, just like the level of mortgage rates can impact homeowners and what their payment schedules look like, they can impact the timing of mortgage-backed securities cash flows. Consider an environment where rates fall and homeowners refinance their mortgages. Let's use an example, Mike, where the mortgage rate does fall to 4% or so. And we get this huge flurry of people who have mortgage rates of 5% or more, for example, and they refinance. 

Well, when you refinance, you're paying off your previous loan. So that payoff just gets flowed through right to the mortgage-backed securities holders. That's called prepayment risk. And it's a risk because it usually happens when interest rates are falling. So if you invested in mortgage-backed securities, say, a year ago, and average yields were close to 6% or more, but if they've since fallen, and now you're getting your principal back faster, you're probably reinvesting those proceeds into lower-yielding securities now. So that's something to consider when you're considering mortgage-backed securities, just the timing of payments, very, very different from traditional bonds.

You hit the point about are they all created equally?

There's a lot of different types of mortgage-backed securities out there. We think the ones to focus on are the higher quality ones. So mortgages backed by Ginny Mae, which are backed by the full faith and credit of the U.S. government, or mortgage-backed securities from Fannie Mae or Freddie Mac, which are implicitly backed by the U.S. government. And an index of those sort of mortgage-backed securities offers yields near 4.5% or 5%. That compares pretty favorably to the average yield of investment grade corporate bonds.

But when we think of investment grade corporate bonds, they tend to have average credit ratings of single A or BBB, the bottom two rungs of the investment grade credit spectrum, where those agency-backed mortgage-backed securities have credit ratings of AA, like the U.S. government. So from a credit risk standpoint, a AA rating is considered to have very low credit risk, while a single A or BBB rating is considered low to moderate.

MIKE: Well, another bond area that I'm really interested in right now and getting your opinion on is international. International stocks are actually outperforming the U.S. year to date. Is the same true with bonds? U.S., of course, has staggeringly high debt that's only going up, while interest rates on Treasuries are falling. So is this a good time to be expanding the international portion of my fixed income portfolio?

COLLIN: We do think it's a good time, but it could also be a good time just to introduce it, Mike. We find that a lot of U.S.-based investors have a home bias, and they might not have any foreign bond holdings. This could be a good time to just introduce the asset class as the outlook is a bit more attractive today than it's been in a while. There's a few things you want to consider if you're considering investing in international developed-market bonds. The first is that they tend to have lower yields than U.S. Treasuries or U.S. high-quality bonds.

So the index that we track for global bonds is the Bloomberg Global ex-U.S. Dollar Aggregate Index. Its average yield at the end of October was 2.7%. That compares to 4.3% for the Bloomberg U.S. Aggregate Index. So you're seeing you're already kind of at a yield disadvantage. That's because of the makeup of that global index, about 55% of the index is in euro-denominated or yen-denominated bonds. And the European Central Bank has a lower policy rate than the Federal Reserve. The Bank of Japan has a lower policy rate than the Federal Reserve. So they tend to have lower yields. 

Now, the second thing to consider is that currency movements matter. And they can matter a lot when yields are low. The dollar has declined significantly this year. And that means if you're in a local currency investment, a drop in the dollar usually pushes up local currencies. That's been really good for global bond investments this year. Through the end of October, that global ex-U.S. Dollar Index has generated a total return of 8.3%, and currency gains represented 6.9% of that. So most of the total return was due to currency gains as opposed to income or price appreciation.

Now, we think there's room for the dollar to decline from here as the Fed cuts rates, even if they cut gradually. Because if we look at some of the other global central banks, a lot of them are done, or close to being done, cutting rates. So we can see interest rate differentials—what the U.S. offers relative to other developed market governments, we can see that continue to shrink. And when interest differentials shrink, you might see money flow from the U.S. into other currencies as the opportunity looks a bit more attractive. 

Now, one point on debt levels, Mike. High debt levels are an issue with a lot of these developed market countries as well. So while we think they're relatively attractive right now, given that their yields are up a little bit over the past 15 years, and that the weak dollar can support their returns, our view that they're relatively attractive isn't necessarily because they're a model of fiscal efficiency.

MIKE: Yeah, well, speaking of models of fiscal efficiency, I think we can all agree that the U.S. is not one of those. Back in the summer when the One Big Beautiful Bill Act was passed, I think one of the things that everyone realized is that no one in Washington seems to care about the debt or the budget deficit anymore. That One Big Beautiful Bill had a $5 trillion increase in the debt ceiling, as you mentioned. And there was some turmoil in the bond market where it felt like maybe the so-called bond vigilantes were back. There was some uneasiness that maybe the appetite for U.S. Treasuries was waning. Now it seems like that concern has faded again. So are there still plenty of buyers out there? And how concerned are you about the long-term fiscal mess impacting the bond market?

COLLIN: We are a little concerned, but it's not really a huge driver of our outlook. And I say that because we've looked into our level of debt and what it means for Treasury yields over time, and there just isn't much of a relationship. So we can't say, "Oh well, once we get to X level of debt or debt-to-GDP ratio, that it's going to spell trouble."

But we worry that, at some point, a meaningful relationship can present itself. You mentioned people kind of forgetting about this or not talking about it. We continue to see our debt continue to rise. Just before this discussion, Mike, I wanted to kind of look into this. And at the end of last year, the amount of marketable Treasuries outstanding, it was 28.3 trillion. And then at the end of September of this year, it was 29.7 trillion. So more than a trillion increase in just nine months. So our debt continues to grow. And the more debt we issue, the more buyers we need to find. And there might be a point where yields need to at least stay elevated or maybe rise a little bit more to attract that marginal buyer. 

You asked about the idea of, are there a lot of buyers out there? There does appear to be a lot of buyers out there. One thing that makes a lot of headlines is foreign buyers. And foreign investors own a lot of our Treasuries, but lately it's been private investors doing most of the heavy lifting, as opposed to central banks. If we look at official foreign holdings, that's usually other developed-market central banks. Their Treasury holdings have held near 4 trillion for over a decade.

There's two ways to look at that. First, there's really no evidence that there's been mass selling. I know there's a lot of concerns that people might just start selling our debt. That doesn't appear to be the case. But it also shows that central banks' holdings aren't keeping up with our debt growth because our debt does continue to rise. Now, foreign private investors have kind of filled that void. They've more than doubled their holdings over the past six years. That can be a good thing or a bad thing. The good thing is that it's a source of demand. It's buyers for our Treasuries, but that demand might be less sticky than foreign central banks. Central banks hold Treasuries for a number of reasons, to have U.S. dollars for reserve purposes, things like that. If you're a private investor, you might be a little bit more opportunistic, maybe looking for relative value out there. And if there's better opportunities elsewhere, maybe that foreign private demand declines a little bit from here. 

Adding this all up, it's one factor we look at that our debt levels continue to rise. It's one factor that might keep long-term yields elevated. So maybe 10- to 30-year Treasury yields keep them elevated, but we're not worried that it's going to suddenly send them significantly higher.

MIKE: Well, I appreciate your thoughts that there are still plenty of buyers out there. But before we wrap up, I want to circle back to something I started the very top of the podcast with, and that's sort of the perception of bonds generally. Obviously, I know you have a high opinion of bonds, and I have no doubt that you're getting this question a lot and probably will have a good answer for it. I just have to ask, in an environment where the S&P 500 is up about 17% year to date and about 24% annualized over the last three years, why should I be considering bonds at all?

COLLIN: We still think bonds can make a lot of sense, but I'd want to highlight that every investor is different. And depending on your time horizon, your risk tolerance, what your goals and objectives are, that should really dictate how many bonds and how many stocks you hold. But I think bonds can make a lot of sense for investors in or near retirement. After all, we refer to bonds as fixed income. And that's what a lot of people in retirement are looking for.

You highlighted the strong equity returns. That does make me a little bit nervous in that it's maybe reframed expectations a little bit. So I always like to highlight that past performance is no guarantee of future results. I think there's two reasons I'll point to about owning bonds today. The first is drawdowns. So yes, equities have performed very well lately, but stocks tend to be pretty volatile, and they tend to have larger drawdowns. And if we look at the drawdowns, peak-to-trough declines in value of high-quality bonds, they tend to be much lower drawdowns with high-quality bonds than with stocks. Since its inception in 1976, the Bloomberg U.S. Aggregate Index has only suffered five calendar year losses. Aside from 2022, which was a pretty big decline, it was a 13% decline. Aside from that year, the worst calendar year return was less than a 3% loss. So drawdowns, I think, matter.

And the starting yields today, when combined with stocks in your portfolio, can probably help you reach your goals. When you're sitting down and coming up with a financial plan, you probably think about what total return you might need to reach your goal. It's a very important question to ask. Now, for a while, bonds couldn't really help much if they were only offering yields of 1, 2, 3%. If you needed a 6% total return to help you reach your goals, 2% bonds aren't really going to do much of the heavy lifting. 

If you can get blended yields of 4 to 5% now with high-quality bonds, that means that stocks don't need to do as much of the heavy lifting as they used to. So I think that's important to introduce and hold a portfolio of both—of stocks and high-quality investments like intermediate term-Treasuries, investment grade corporates and munis, maybe agency mortgage-backed securities. And this can kind of help you de-risk your portfolio, but probably still reach your goals.

MIKE: OK, so you've made some good points on why we should all have bonds. You mentioned intermediate-term Treasuries, but what else should we be thinking about on the fixed income side of our portfolios right now?

COLLIN: Our other guidance we've been talking about is to not have too much risk in your bond portfolio because we think it makes sense to take risk if you're being compensated well, but that doesn't really seem to be the case right now. Now, some listeners here may have heard some headline-grabbing defaults lately, or maybe they heard J.P. Morgan CEO Jamie Dimon referring to the defaults as cockroaches, meaning if you see one default, there will be others.

Now, I don't need to go into too many more details, but if we're just talking about default risk on the rise, as an investor, I'd want to make sure that I'm being compensated for that because defaults have been rising lately. Yet we're seeing yields offered on riskier investments still pretty low. So when we look at things like high-yield bonds or sub-investment-grade corporate bonds, the extra yield they offer relative to Treasuries to kind of compensate for the risk is very low right now, but yet default risk, we think, is on the rise. So we don't think that risk/reward looks too attractive today. We'd stick with highly rated bonds because we think you can get what we think are attractive yields without taking too much risk. 

We like intermediate term maturities right now. That's usually average maturities in the four to 10-year range. I think that's a good balance between focusing too much on short-term bonds, which opens the door for reinvestment risk as the Fed cuts rates. But we don't want to focus too much on long-term bonds in case sticky inflation or fiscal concerns pull up long-term yields, which could pull the value of long-term bonds down pretty sharply. And then one final point, Mike, we like Treasury Inflation Protected Securities (or TIPS). We think they can make sense for investors who are worried about inflation. They're like traditional Treasuries in that they're backed by the full faith and credit of the U.S. government, but their principal values are indexed to the CPI, the Consumer Price Index, one of the key inflation indicators. So it's a good way to invest in something that has a pretty high quality but also can help you protect against inflation over the long run.

MIKE: Well, Collin, that's great advice, and this has been a great conversation. You have a real knack for explaining a pretty complicated part of the market, a pretty intimidating part of the market, in very understandable terms. I really appreciate that. So thanks so much for joining me today.

COLLIN: You're welcome. Thank you so much for having me join again.

MIKE: Well, that's all for this week's episode of WashingtonWise. We're planning to take a break until after Thanksgiving. But if the government shutdown ends, we may add a special episode to focus on that. So take a moment now to follow the show in your listening app so you get an alert when the next episode drops, and you don't miss any future episodes. And don't forget to leave us a rating or a review. Those really help new listeners discover the show. For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript.

I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy and keep investing wisely.