What pros wish everyone knew about falling rates
Here’s the quiet part said out loud: falling rates aren’t a free lunch. They feel great on your bond statements and mortgage quotes, but they also whisper “slower growth” and “tighter profits” under the hood. In Q4 2025, the people doing this well aren’t guessing the very next Fed move, they’re mapping ranges, stress‑testing income needs, and deciding, deliberately, what to lock and what to keep flexible. That’s the whole game right now.
Quick reality check with actual numbers. Historically, duration wins when yields drop. The rule of thumb still works: price change ≈ duration × move in yields. So a 7‑year duration core bond fund can gain roughly 7% if yields fall 100 bps. That’s the good part. But, this is where it gets messy, falling rates often arrive with widening credit spreads. During the 2020 recession, ICE BofA High Yield OAS spiked above 1,000 bps in March 2020, while Investment Grade OAS touched roughly 370 bps. In 2008-09, high yield spreads blew out near 2,000 bps and IG spreads approached ~600 bps. The long-run averages are closer to ~500 bps (high yield) and ~140 bps (investment grade). Point is, Treasuries can rally and credit can still sag. Both things can be true at once.
And earnings? They’re not immune. S&P 500 earnings fell about 22% in 2020 from peak-to-trough and by more than 40% through the 2008-09 cycle (depending on the earnings measure you use). Lower discount rates can help equity multiples, but if growth slows, the “E” in P/E gets shakier. I’m not trying to overcomplicate it, but if you only watch rates and ignore earnings risk, you’re playing with half the dashboard turned off.
Falling rates help duration, but they also flag slower growth risk, higher earnings uncertainty, and wider credit spreads in recessions. It’s not bearish, it’s just the actual mechanics.
So what should readers expect to get from this section? Three practical things you can actually use, starting now:
- Income planning beats point forecasts. Build cash flow ladders and spending reserves by need-dates, not by a single rate guess. A 6-12 month cash bucket, a 1-3 year CD/T-bill ladder, and a core bond sleeve with 5-7 years of duration can work together so you don’t have to sell risk assets on a bad tape.
- Decide what to lock and what to float. Lock: borrowing costs (refis, term debt), and deposit/CD ladders you’ll actually spend. Float: equity beta and optionality where long-run upside compensates for volatility. If you need the cash on a date certain, don’t gamble it on the Fed path.
- Respect credit spread math. In recessions, spreads usually widen even as Treasuries rally. If you want rate exposure, use higher-quality duration; if you want carry, size high yield and loans as if spreads could revert toward their historical stress ranges (think 800-1,000 bps in bad tape, based on 2020 and 2008 history).
Circling back to that first point, because it’s the one people skip: your income plan is the buffer that lets you be patient with the rest of the portfolio. If rates fall and the curve shifts around (and yes, curves can steepen while the front end drops ) you’ll be glad you locked the liabilities you control and kept your upside where it belongs. And if that sounded a bit wonky, fair, but it’s the difference between “nice quarter” and “we met the plan” when markets get loud.
Falling rates 101: what actually changes in portfolios
Quick reality check: when rates roll over late-cycle, a lot of stuff moves at once. Some of it helps, some of it bites. And yes, it’s confusing because “rates down” looks bullish on the surface, until spreads widen or earnings slow. Here’s the clean version I use with clients and, honestly, with myself when the tape gets noisy.
Rule-of-thumb: Price move ≈ Duration × Yield change. A 1% (100 bps) drop with 7-year duration is ~7% price up, before convexity. Longer duration magnifies it.
Duration up, credit quality up. If you expect cuts, you want the rate sensitivity but not the default sensitivity. High-quality, long-duration government and agency bonds usually do the stabilizing. As a reference point, the ICE BofA 10+ Year US Treasury index has often run an effective duration in the mid-to-high teens in recent years, call it ~17-18, so a 50 bps drop can be a high-single-digit tailwind by itself. That’s the ballast you actually feel in a drawdown.
Reach-for-yield down. Late-cycle, lower-quality credit tends to suffer from spread widening even as Treasuries rally. We saw the pattern starkly in prior stress windows: in March 2020, ICE BofA US High Yield OAS spiked to roughly 1,080-1,100 bps, while BBB OAS ran up near ~400 bps (both 2020 data). Back in 2008-2009, HY OAS peaked around ~1,900 bps. Point being, carry can vanish in a hurry when spreads gap. If you want rate exposure, use quality duration. If you want credit carry, size it like spreads can revisit four digits in a bad tape. That’s not fear-mongering; it’s just what the history shows.
Yield curve shape: steepening is common. When the cutting cycle starts or the market prices it hard, the front end usually falls more than the long end. Example: from January to August 2020, the 2-year Treasury yield dropped from about 1.6% to ~0.15% (≈ −145 bps), while the 10-year fell from roughly 1.9% to ~0.7% (≈ −120 bps). Same sign, bigger move up front, classic late-cycle steepening after an inversion. This year, the same logic applies: as policy expectations lean easier, I’d rather own more 5-10 year duration than play fancy barbell games that rely on perfect timing. I know, that sounds boring. Boring works.
Portfolio shifts that actually stick:
- Bonds: Add high-quality duration (Treasuries, agencies). Keep spread beta modest. If you need to own IG corporates, tilt up in quality (A/AA) and extend a bit on the curve rather than stretching down in credit.
- Credit: Limit CCC and loan exposure. If you own HY, barbell toward BBs and keep position sizes assuming spread VaR can double. In 2020, HY prices fell >20% peak-to-trough as OAS blew out, that’s the scale to underwrite.
- Cash/short duration: Expect reinvestment risk. As front-end rates fall, that juicy 5% money market yield won’t stick. Term out to lock something real, even if it’s not the top tick.
Now equities, this is where folks get tripped. Lower discount rates lift present values, which helps multiples. But in late-cycle, earnings sensitivity to slower demand becomes the swing factor. Multiple up, E down can net to “meh.”
- Factor tilt: Quality balance sheets, high free cash flow, and less use. You don’t need to overthink it. Names that self-fund have optionality when credit tightens.
- Dividend safety > dividend yield. Yield tourists tend to chase the highest sticker. Don’t. In slowdowns, dividend cutters usually lag badly. Historically, dividend growers and “quality dividend” cohorts have outperformed during stress because they protect the stream, not just the sticker. For context, during 2020’s shock, S&P 500 dividend strategies that emphasized growth and quality held up meaningfully better than high-yield-only baskets (2020 performance records from index sponsors show that spread).
- Valuation math: In 2019-2020, as the 10-year fell by roughly 150 bps peak-to-trough, the S&P 500 forward P/E expanded from the high teens to the low 20s (FactSet/S&P data at the time). That’s your playbook, rates can pull multiples higher, but earnings revisions decide the outcome.
Circling back, because I glossed it earlier, the reason long Treasuries stabilize a portfolio isn’t magic, it’s convexity plus flight-to-quality behavior. When growth wobbles, duration’s positive convexity kicks in while spreads do the opposite. If the cycle softens more than expected later this year, you’ll be glad you swapped reach-for-yield for quality duration. And if it doesn’t, well, you still own liquid ballast you can redeploy. That optionality is the point.
Fixed income that earns its keep right now
This is where you actually protect the portfolio instead of just hoping equities behave. The playbook is pretty straightforward: extend duration deliberately, upgrade credit, and build a ladder you won’t hate if rates keep grinding lower. History backs this up. In the 2001 recession, high-quality government bonds posted positive returns while credit spreads widened. In 2008, the Bloomberg U.S. Treasury Index returned roughly +13% for the year, while U.S. high yield fell about -26% (index data from Bloomberg/ICE). In the 2020 recession shock, long Treasuries were up sharply (the Bloomberg U.S. Long Treasury Index was ~+17-18% for 2020), and high-yield spreads blew out to over 10% option-adjusted in March 2020 (ICE BofA US High Yield OAS peaked above 10%). That pattern isn’t perfect, but it’s consistent: in downturns, duration helps, lower-rated credit doesn’t.
How to put that to work without getting cute:
- Extend duration in stages. Start with a core Treasury/AGG-style sleeve (the Bloomberg U.S. Aggregate Bond Index carried an effective duration near 6 years in 2024, per Bloomberg). Then layer in a hedging sleeve of 10-30 year Treasuries. Long Treasury duration is typically ~17-18 years for the 20+ year index, which is why it actually moves the needle when growth wobbles. I like doing this in 2-3 clips over several weeks instead of one gulp, prices can be jumpy around data and Fed meetings.
- Favor investment-grade over high yield. Recessions tend to widen spreads. In 2008, HY OAS blew out above 20% (ICE data), and even in 2020 it sprinted past 10% in a hurry. IG held up better: IG OAS peaked near ~6% in 2008 and ~4% in March 2020. The point: you usually get paid to wait in IG; HY can turn into equity-without-the-upside at the wrong moment.
- Keep some TIPS for surprise inflation. Even if CPI is moderating, shocks happen. In 2022 TIPS significantly outperformed nominals of similar duration during the inflation spike (U.S. CPI ran 8.0%+ YoY for much of mid-2022). A 10-20% TIPS sleeve is a decent insurance policy. If inflation undershoots, it’s not fatal; if it re-accelerates, you’ll be glad you had it.
- Barbell the liquidity and the hedge. Short T-bills on one side for cash needs and optionality; long Treasuries on the other for drawdown hedging. The middle (intermediate credit) is fine as core, but the barbell amplifies what you actually want, dry powder and convexity.
- Municipals, but with quality. For taxable investors, favor AA/AAA essential-service revenue bonds and strong GOs. And always check taxable-equivalent yield. Quick math: at a 35% marginal bracket, a 3.0% tax-exempt muni is a ~4.6% taxable-equivalent (3.0% / (1 – 0.35)). If you’re in a high-tax state and using in-state paper, the TEY can be even higher. Just mind call structures and liquidity.
A couple of real-world guardrails. First, yes, yields today are still higher than the 2010s average, so you’re not giving up carry by owning quality the way you were pre-2020. Second, I’d avoid timing perfection. I’ve tried to “thread the needle” on long-end buys more than once; honestly, scaling in worked better. Third, if this sounds complicated, well, it kind of is. But the core idea isn’t: own ballast that rallies when risk sells off, and avoid credit that behaves like equities at the wrong time.
One last thing from personal experience: in late 2008 we set up ladders of Treasuries and high-grade munis for clients who were nervous. A year later they weren’t thrilled they missed a chunk of the equity snapback, but they slept fine and had liquidity to rebalance. That’s the trade you’re making here, less FOMO, more control.
Frequently Asked Questions
Q: How do I adjust my bond mix for falling rates without taking dumb credit risk? This feels messy.
A: You’re right, it’s messy. Here’s a simple, workable playbook I use with clients (and in my own accounts):
- Extend duration, but not to the moon: add about 1-3 years of duration in your core high‑quality bonds. If your core was ~4 years, nudge it toward 5-7. That keeps you positioned for a 50-100 bps drop (roughly +5-7% on a 7‑year fund) without blowing up if spreads widen.
- Tilt up in quality: keep 70-90% of fixed income in Treasuries/Agencies/IG, only 0-10% in high yield right now. In recessions, Treasuries can rally while credit sags, spreads have historically jumped from ~140 bps IG / ~500 bps HY long‑run averages to 370+/1,000+ in 2020.
- Keep a cash bucket: 6-12 months of withdrawals in T‑bills or a short ladder so you’re not forced to sell risk assets on a bad day.
- Barbell the middle: pair short T‑bills (liquidity) with some intermediate/long Treasuries (rate sensitivity). I keep a small long‑Treasury sleeve as my ‘shock absorber.’
- Rebalance rules: trim winners and add to laggards if bond yields move 50-75 bps or your allocation drifts more than ~5% from target.
- Tax angle: in taxable accounts, use high‑quality munis for the core (watch AMT on certain issues).
Q: What’s the difference between extending duration and adding high yield when rates are dropping?
A: Extending duration bets on rates falling; adding high yield bets on credit holding up. Very different risk levers:
- Duration: Mostly interest‑rate risk. If the 10‑year falls 100 bps, a 7‑year duration fund could gain ~7%. Works best when growth is slowing and the Treasury curve rallies.
- High yield: Mostly credit‑spread risk. In recessions, spreads often widen (2020 HY OAS jumped above 1,000 bps). That can offset the benefit of lower rates and leave HY flat or down while Treasuries rally. Practical takeaway: if you’re positioning for falling rates tied to slower growth, prefer adding duration in Treasuries/IG over loading up on HY. Keep HY small (think 0-5% tactical) until spreads are already wide and you’re getting paid for the risk.
Q: Is it better to hold long Treasuries or build a ladder if I expect a mild recession?
A: Both can work; they solve different jobs:
- Long Treasuries (20-30 year): Best hedge against a growth scare. If rates fall fast, they can rally hard. But they’re volatile if the rate path surprises higher.
- Ladder (6-36 months, or 1-5 years): Smooths reinvestment, reduces timing risk, and gives you predictable cash flows. Less upside if rates drop sharply, but fewer headaches. A workable middle path: keep a 2-4 year ladder for cash needs and stability, then add a targeted 10-20% sleeve in long Treasuries as your recession hedge. If you get the mild recession and a 75-100 bps drop, the long‑end sleeve does the heavy lifting; the ladder funds spending and lets you wait. If you’re very rate‑sensitive (retirement income, big 2026 withdrawals), bias to the ladder. If your main goal is downside equity protection, bias to the long‑end sleeve.
Q: Should I worry about my stock allocation if rates fall, don’t lower yields mean higher P/Es?
A: Lower yields can support higher multiples, yes, but recessions hit earnings. In 2020 S&P 500 earnings fell ~22% peak‑to‑trough; 2008-09 was over 40% depending on the measure. So, I’d do three things now:
- Balance factors: pair some quality/defensive (health care, staples, utilities) with your growth. Keep cyclicals modest until the earnings outlook stabilizes.
- Hold a Treasury hedge: even a 10% long‑Treasury sleeve can offset equity drawdowns when growth slows.
- Set rules, not vibes: rebalance if equities move ±10% vs target, and keep 12 months of planned withdrawals outside stocks. Net: don’t bail on equities because rates fall; just assume the “E” might wobble and make sure the bond side can actually hedge it.
@article{asset-allocation-for-falling-rates-recession-pro-guide,
title = {Asset Allocation for Falling Rates & Recession: Pro Guide},
author = {Beeri Sparks},
year = {2025},
journal = {Bankpointe},
url = {https://bankpointe.com/articles/asset-allocation-falling-rates/}
} 