In the third quarter of 2025, the Bloomberg US Aggregate Bond Index posted a gain of 2.03%, contributing to a robust 6.13% year-to-date performance, marking its best nine-month start since 2020. This period was characterized by significant market developments, including the implementation of tariffs, a noticeable softening in the labor market, and a shift towards an accommodative stance by the Federal Reserve following its Jackson Hole meeting. Despite these economic and political headwinds, risk assets demonstrated resilience, with investor demand maintaining tight spreads. The quarter's dynamics underscored a heightened focus on central bank policies, as credit markets remained stable amidst increasing macroeconomic uncertainty.
The Federal Reserve experienced notable shifts in its leadership during this quarter. Following an unexplained absence from the July FOMC meeting, Governor Adriana Kugler unexpectedly resigned on August 1st, months before her term's expiration in January 2026. This vacancy was swiftly filled by Stephen Miran, the current chair of Trump's Council of Economic Advisors, who was nominated and confirmed just before the September FOMC meeting. Miran made an immediate impact, advocating for a 50 basis point rate cut, a move that stood out amongst his colleagues.
Adding to the intrigue, President Trump attempted to dismiss Governor Lisa Cook on August 25th, citing allegations of mortgage fraud. Cook, appointed by President Joe Biden in 2022 for a 14-year term, faced accusations from Bill Pulte of the Federal Housing Finance Agency regarding alleged primary residency claims to secure favorable mortgage terms. However, federal law stipulates that Federal Reserve governors can only be removed \"for cause,\" requiring a due process that allows the accused to respond and present evidence. A federal judge blocked Cook's removal on September 9th, allowing her lawsuit to proceed and for her to retain her position until the case is resolved. This legal battle is now heading to the Supreme Court, with its outcome poised to have profound implications for the Federal Reserve's leadership and its perceived independence from political influence.
Despite these internal upheavals, the FOMC proceeded with its first adjustment to Fed Funds rates since December 2024, initiating an easing cycle. This decision was driven by a perceived \"shift in the balance of risks,\" particularly a rise in \"downside risks to employment.\" Although inflation had seen a slight increase since spring, job growth had considerably slowed, and the unemployment rate had reached levels consistent with full employment. Chair Powell characterized the adjustment as a \"risk management cut,\" suggesting a meeting-by-meeting approach to future adjustments. The Committee's inclination towards easing was further reflected in the September Summary of Economic Projections (SEP), which forecast a median Fed funds rate of 3.625% by year-end, down from 3.875% in June, implying an additional 50 basis points of easing over the remaining two meetings of 2025. While the median estimate for 2026 indicated only one further cut, a considerable dispersion among participants was observed, with the long-run \"neutral\" Fed funds rate remaining stable at 3%. This suggests that most Committee members still view current policy as somewhat restrictive, allowing room to reduce rates to support the labor market without significantly exacerbating inflation.
Historical comparisons reveal similarities to actions taken in 2024. Although the initial rate cut in September 2024 was 50 basis points compared to 25 basis points in September 2025, the FOMC's subsequent moves in November and December 2024 mirrored the current year's pattern of 25 basis point reductions. The updated SEP projections for 2026 and 2027, alongside the unchanged long-term neutral policy rate, underscore the Committee's cautious approach to easing while maintaining a consistent long-term economic outlook.
Recent revisions to labor market data have painted a less optimistic picture of economic strength. The Bureau of Labor Statistics' preliminary benchmark revision for March 2025 non-farm payrolls indicated a staggering 911,000 fewer jobs than previously reported, translating to an average monthly job loss of 76,000. This starkly contrasts prior growth estimates and suggests a more aggressive Federal Reserve easing cycle might be warranted. While this is a preliminary estimate, it follows a similar pattern to 2024's benchmark revision, which saw an initial reduction of 818,000 jobs, later adjusted to 598,000. These significant revisions, particularly the May and June non-farm payroll reports, which were reduced by 258,000 jobs, even led to the termination of the Bureau of Labor Statistics head, raising concerns about data reliability.
Broader labor market indicators further corroborate this sustained weakness. Monthly job gains averaged 102,000 in 2025, significantly lower than the 175,000 in 2024 and 209,000 in 2023. Despite this slowdown, unemployment, while rising from 4.1% in June to 4.3% in August, remains below the \"natural level of unemployment,\" averaging approximately 4.16% in 2024. Meanwhile, the Federal Reserve's preferred inflation metric, the core personal consumption expenditures (PCE), increased by 2.9% year-over-year in August 2024, aligning with market expectations and July's figures. This marks the fifth consecutive monthly increase since April and the highest reading since February 2025. This economic conundrum—simultaneous higher inflation and a weaker labor market—forces the Federal Reserve to prioritize. It appears the Fed is leaning towards stabilizing the labor market, even if it means tolerating slightly elevated inflation in the short term.
The Treasury market demonstrated positive performance in Q3, with the Bloomberg US Treasury Index gaining 1.51%. However, it trailed both corporate and securitized sectors, consequently dampening the overall performance of the Bloomberg US Aggregate Bond Index. Treasury returns were positive across the yield curve, driven by declining rates. The bull steepening curve shift observed throughout 2025 persisted, albeit at a reduced pace compared to previous quarters. The yield spread between 2-year and 10-year Treasuries expanded from 0.33% to 0.54%, while the 2-year and 30-year spread surged from 0.54% to 1.12% by September, reflecting ongoing concerns about the fiscal situation and political gridlock in Washington. The 2-year Treasury yield decreased from 3.72% to 3.61%, and the 30-year Treasury yield slightly slid from 4.77% to 4.73%.
The investment-grade corporate bond market, as measured by the Bloomberg US Corporate Bond Index, achieved its strongest quarterly return since Q3 2024, posting a 2.60% gain. This robust performance was fueled by spread tightening and strong investor demand. Following a brief disruption in Q2 due to tariff announcements, investor risk appetite rebounded, pushing corporate spreads lower. Investment-grade corporate spreads contracted by nearly 10 basis points in Q3, moving from 83.2 bps to 73.81 bps, reaching their lowest level since May 1998. The yield on the Corporate Index mirrored this trend, declining from 4.99% at the start of Q3 to 4.70% in mid-September, before settling at 4.81% by quarter-end. Strong demand from investors led to substantial new issuance, with nearly $400 billion in the quarter, bringing year-to-date issuance to $1.3 trillion, surpassing 2024's pace by 3%.
The securitized market, encompassing mortgage-backed securities (MBS), asset-backed securities (ABS), and commercial mortgage-backed securities (CMBS), delivered another strong performance in Q3, returning 2.38%. This sector has consistently outperformed since the beginning of the year, achieving its best nine-month performance (+6.70%) since 2009. Plain vanilla passthrough MBS led with a 2.43% return, closely followed by collateralized mortgage obligations (CMOs) at 2.30%. Non-agency CMBS also performed well (+1.87%), while shorter-duration ABS showed steady performance (+1.64%) due to attractive spreads and shorter durations. Similar to investment-grade corporate markets, spreads across all securitized segments tightened during Q3. Despite the overall market strength, the quarter saw some headline risk. Subprime auto ABS issuer Tricolor filed for Chapter 7 bankruptcy amid allegations of irregularities and an ongoing Justice Department investigation into potential losses tied to warehouse credit lines. While some smaller subprime auto ABS deals experienced slight spread widening, the broader market reaction remained subdued. The securitized market maintains a constructive outlook heading into Q4.