Investing in a 5% Bond World: The Barbell

Key Takeaways

Good growth, sticky inflation, policy uncertainty and Treasury/AI-related supply are likely to keep long-term yields elevated for the foreseeable future.
The 10-year Treasury yield? Could trade between roughly 4.50% and 5.25% in the near term, with the range skewed toward the upper end.
Investors who want exposure to a 5% bond environment can pair a zero-duration fund with a core-duration vehicle in a barbell approach.

The number one question we tend to receive is: Where are long-term interest rates headed from here? Right behind it is: How do I invest in the bond market, not only for right now but also for the future? In our opinion, investors should be prepared for this elevated “normal” rate setting for the foreseeable future. We wanted to address both questions by examining how to prepare a bond portfolio for a 5% world.

To assess where the U.S. Treasury (UST) 10-year yield may be headed, it is useful to remember how longer-dated UST yields reached their current levels. A confluence of factors, including good growth, sticky inflation, Fed policy uncertainty related to Warsh and supply considerations tied to Treasury issuance and AI, has led the bond market to reprice yields to reflect these changing dynamics.

Against this backdrop, we should ask which, if any, of these forces could change in the months or year ahead. Let’s take a quick look:

Good Growth

Recent data suggest the labor market is steady, providing a solid foundation for personal consumption
AI-related investment should continue to provide support

“Sticky,” Above Fed-Target Inflation

The latest readings for both CPI and PPI came in hotter than expected. Higher energy price pass-through could continue
The AI buildout is expected to continue applying upward pressure on prices

The ‘Warsh-Uncertainty’ Factor

Removal of forward guidance has created elevated policy uncertainty
As a result, the bond market demands a higher term premium (additional yield compensation)

Supply, Supply, Supply

The U.S. budget deficit rose to about $2 trillion in FY 2026. Treasury will need to increase coupon auction sizes in the months ahead
Despite higher long-term rates, funding needs for the AI buildout will continue to require additional debt issuance

The forces that pushed the UST 10-year yield to a more than 20-year high are unlikely to fade soon. For now, however, the back end of the yield curve may have found support near these multi-decade highs. Yields could rise further, but the UST 10-year may now trade in a range of roughly 4.50% to 5.25% in the near term, skewed toward the upper end.

See more: What Is the Doom We Face?

Solution for a 5% Bond World

We continue to highlight the WisdomTree Zero Duration Suite as a cornerstone of fixed income strategy in the current and prospective rate environment. For investors who wish to participate in a “5% bond world,” we suggest pairing this suite with a core-duration vehicle in a barbell approach.

Our high-conviction, in-house barbell solution pairs one of our zero-duration funds (the WisdomTree Floating Rate Treasury Fund (USFR), the WisdomTree Interest Rate Hedged U.S. Aggregate Bond Fund (AGZD) or the WisdomTree Interest Rate Hedged High Yield Bond Fund (HYZD)) with the WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY). This approach allows bond investors to participate in a “5% bond world” while seeking to mitigate potential volatility and interest-rate risks.

Investors seeking a more active fixed income solution could pair one of our zero-duration funds with the WisdomTree Bianco Total Return Fund (WTBN).

Conclusion

As we have consistently emphasized, we are not proponents of trying to perfectly time the peak in bond yields. In our opinion, the barbell solutions outlined here offer fixed income investors a time-tested strategy that provides some protection when extending duration.

Kevin Flanagan, Head of Investment and Fixed Income Strategy

Important Risks Related to this Article

There are risks associated with investing, including possible loss of principal. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.

USFR: Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but may decline in value. Fixed income securities will normally decline in value as interest rates rise. The value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Due to the investment strategy of this Fund it may make higher capital gain distributions than other ETFs. The Fund invests in the securities included in, or representative of, its Index regardless of their investment merit, and the Fund does not attempt to outperform its Index.

AGZD: Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. The Fund seeks to mitigate interest rate risk by taking short positions in U.S. Treasuries (or futures providing exposure to U.S. Treasuries), but there is no guarantee this will be achieved. Derivative investments can be volatile and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. The Fund may engage in “short sale” transactions of U.S. Treasuries where losses may be exaggerated, potentially losing more money than the actual cost of the investment and the third party to the short sale may fail to honor its contract terms, causing a loss to the Fund. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Due to the investment strategy of the Fund, it may make higher capital gain distributions than other ETFs. The Fund invests in the securities included in, or representative of, its Index regardless of their investment merit and the Fund does not attempt to outperform its Index.

HYZD: High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. The Fund seeks to mitigate interest rate risk by taking short positions in U.S. Treasuries (or futures providing exposure to U.S. Treasuries), but there is no guarantee this will be achieved. Derivative investments can be volatile and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. The Fund may engage in “short sale” transactions where losses may be exaggerated, potentially losing more money than the actual cost of the investment and the third party to the short sale may fail to honor its contract terms, causing a loss to the Fund. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Due to the investment strategy of the Fund, it may make higher capital gain distributions than other ETFs. The Fund invests in the securities included in, or representative of, its Index regardless of their investment merit and the Fund does not attempt to outperform its Index.

AGGY: Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Due to the investment strategy of the Fund, it may make higher capital gain distributions than other ETFs. The Fund invests in the securities included in, or representative of, its Index regardless of their investment merit. The Fund does not attempt to outperform its Index.

WTBN: Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. The Fund invests in the securities included in, or representative of, its Index regardless of their investment merit, and the Fund does not attempt to outperform its Index.

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