Inflation has not yet led to a strong rebound in the bond market, US bonds enjoy their best first half performance in 2020.

Although bond traders were worried about inflation in the first half of 2025, the reality was that inflation did not reappear as expected. Because of this, the US bond market had its strongest performance in the first half of the year since 2020. As of June 30th, the yield on 10-year US bonds had decreased by 35 basis points, the largest decline in the first half of the year in the past five years. As bond yields are inversely related to prices, a decrease in yields means an increase in bond prices, signaling a return in investor demand. The key factor driving the strength of the bond market was the disintegration of the narrative of "rising inflation". Inflation is the bond market's number one enemy because it erodes the real purchasing power of future bond interest payments. When market expectations for future price increases decrease, the attractiveness and value of existing bonds rise. In the spring of this year, tensions in the Middle East briefly escalated with Israel and Iran on edge, leading to concerns in the market that this would cause oil prices to soar, triggering global price increases. However, as tensions eased and war worries diminished, US crude oil prices, which had briefly surpassed $75 per barrel, quickly fell back to below $65, providing substantial support for easing inflation concerns. BMO Capital Markets strategists Vail Hartman and Ian Lyngen noted in their report, "The lack of further escalation in the Middle East conflict has weakened the inflation pressure that might have exacerbated it, which is a substantial positive for US bonds." Furthermore, even though businesses have increased costs due to tariffs, they have not significantly passed these cost pressures on to consumers. Data shows that the total amount of tariffs paid by US businesses in May 2025 reached $22 billion, setting a monthly record, which also led to a significant increase in federal tariff revenue. However, consumer inflation in May only increased by 0.1% month-on-month, below the market's expectation of 0.2%, indicating that inflation transmission is still not clear. Despite this, economists generally believe that tariffs have a lagged effect on inflation. Seth Carpenter, chief economist at Morgan Stanley, and his team pointed out in a research report, "Tariffs were gradually implemented in February and March, and significantly increased in April, so it is still too early to judge whether they have significantly increased inflation." They expect that the next two months' inflation data will better reflect the real trend of price increases. In the absence of clear data, bond market participants have generally reduced their concerns about inflation and subsequently lowered their yield requirements. In addition to inflation, investors' expectations for the path of interest rates have also changed significantly. At the beginning of the year, the market generally believed that the Fed's room for rate cuts in 2025 was limited. However, most traders now expect the Fed to cut rates to the 3.5%-3.75% range by December, while current rates remain at their highest level of 4.5%. This shift is due to the continued downward revision of economic growth expectations, prompting the market to bet that the Fed will adopt a more accommodative policy. Furthermore, actions by the Trump administration to focus early on the future chair of the Fed have also heightened expectations in the market for a more dovish policy turn. Rick Bensignor, president of Bensignor Investment Strategies, wrote in a report, "The significant change in the current market is that Wall Street has begun to anticipate a more dovish new chair replacing Powell." He further noted that if the economy continues to weaken, the low yield levels seen in April (10-year bond yields of 4.16% and 3.72%) may come back into focus for investors. "In my view, the possibility of lower rates remains high."