Tilting portfolios toward non-US bonds has been a successful strategy for fixed-income allocations in 2025. The Federal Reserve’s recent pivot to could keep the trend humming through the rest of the year.
Foreign bonds have decisively outperformed the US fixed-income benchmark year to date, based on a set of ETFs through yesterday’s close (Sep. 25). The top performer: government bonds issued in emerging markets (), a category that’s up 14.5% so far in 2025 , far above the 5.9% rise for a benchmark US portfolio of Treasuries and investment-grade corporates ().
In fact, all the foreign-bond funds in the chart above are beating the US benchmark this year.
Notably, hedging foreign exchange risk has been a losing proposition in 2025, as shown by the weak performance of Vanguard Total International Bond Index Fund ETF (), which routinely employs hedging strategies to minimize volatility in exchange rates.
Hedging F/X has been a headwind this year for American investors because the has weakened. The US Dollar Index has shed more than 9% year to date. All else equal, the value of foreign assets rises in US dollar terms when the greenback falls against other currencies.
Expectations that the Fed will continue reducing interest rates is a factor weighing on the dollar. Lower US rates tend to make foreign bonds more competitive vs. American fixed-income assets, absent a commensurate drop in offshore yields. Fed funds futures are pricing in an implied 88% probability that the central bank will cut its target rate again at the next FOMC meeting on Oct. 29.
In the wake of yesterday’s upbeat US economic news, the market is focusing on whether the Fed will be able to continue with policy easing. The source of fresh uncertainty on the path of rate cuts: growth for the second quarter was revised up to a sizzling 3.8% while fell again, printing at close to the lowest level of the year.
The latest news suggests that the economy and the labor market may be stronger than recent analysis suggested. If so, the US dollar’s decline this year may stabilize, providing support to US bonds in relative terms vis-à-vis foreign counterparts.
Short of a new round of US rate hikes, which looks unlikely at this point, foreign bonds remain on track to outperform US fixed income by a wide margin for the full calendar year.
What could change the outlook? If US continues to creep higher, the Fed could be forced to rethink its dovish pivot.
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