THE STOCK MARKET IS IN CHAOS. WHY ARE TREASURY YIELDS ABOVE 4%? / THE WALL STREET JOURNAL

The Stock Market Is in Chaos. Why Are Treasury Yields Above 4%?

Bond traders appear to be betting on a return to normal before long

By Jon Sindreu

Federal Reserve Chair Jerome Powell Photo: will oliver/Shutterstock

As if investors didn’t have enough calamities to deal with in the stock market, bonds also refuse to give them a break.

Yields on 10-year Treasurys were hovering above 4.2% Tuesday—lower than their 4.6% level at the start of the year but still stubbornly high. 

On Monday, even as equities tumbled for a third straight day, 10-year yields edged higher and 30-year yields marked the largest one-day gain since March 2020.

This is a headache for those seeking to escape the stock-market carnage. 

Since the turn of the century, Treasurys have mostly acted as a haven during selloffs, with notable exceptions such as the 2007-08 financial crisis and the 2022-23 supply-chain collapse. 

It is also a problem for the steadfast who remain in equities. 

Though the decline in stocks has neared bear-market territory, making them cheaper, Wall Street is simultaneously cutting profit forecasts, leaving the S&P 500 with a forward 12-month earnings yield of just 5.5%. 

Bonds pose serious competition to a potential equities rebound such as the one that started to unfold Tuesday morning, especially since equity analysts haven’t yet fully priced in the high recession risk. 

If a prolonged downturn materializes, Treasurys would typically be big winners.

The big question, then, is why they aren’t rallying more. 

The answer may be that bond traders are reflexively pricing in the simplest scenario—a short-term economic shock followed by a rapid return to the status quo.

That could open opportunities for those who are less blasé. 

Of course, it could be argued that yields shouldn’t go down because Federal Reserve Chair Jerome Powell won’t budge on interest rates even in the face of a recession. 

It is a reasonable worry. 

Trump’s tariffs put the central bank in a bind because, even if consumers and businesses slash spending, import prices will surge.

Yet the market is only pricing in so much monetary restraint. 

Derivatives actually suggest a 76% probability that the Fed will reduce borrowing costs by a full percentage point or more by year-end, according to CME FedWatch.

Indeed, 1-year and 2-year Treasury yields have come down, unlike longer-term ones, also signaling expectations for near-term Fed easing.

Contracts linked to inflation help unpack this further. 

Over a one-year horizon, bond yields are being pulled in two directions, with investors anticipating a surge in tariff-related inflation but also an economic slowdown joined by looser monetary policy in “real” terms. 

Two years ahead, the inflationary shock is seen dissipating, but the Fed is still expected to be aiding the economy. 

Beyond that, fixed-income markets foresee inflation-adjusted rates being as high as they were expected to be before Trump’s tariffs, even though they believe inflation itself will be lower.

The latter is an odd forecast, as Trump’s protectionism more likely points to slower productivity and higher inflation, even over the long term. 

Perhaps investors think that the Fed will react to that by applying today’s restrictive stance to a weaker economy, thus yielding lower average price increases.

But it is more likely that traders have given up on predicting long-term economic growth given the current chaos.

Elida Rhenals, co-head of inflation at AXA Investment Managers, pointed out Monday that “markets are conditioned for mean reversion; they are not prepared for paradigm breaks.”

There are probably other forces at play, such as some investors rotating out of bonds to buy the equity dip Monday and Tuesday, as well as anticipation of new Treasury issuances this month and an OPEC announcement that has led crude prices to fall.

The scariest possibility is that markets are becoming concerned about the government’s ability to refinance $37 trillion of public debt. 

The U.S. budget deficit is already above 6% of gross domestic product, and a recession would widen it further by lowering tax revenue and raising unemployment benefits. 

But such fears would likely show up in disruption to short-term funding markets—the system’s lifeblood, largely built on the safety of Treasurys—and, unlike in 2007, this hasn’t happened. 

Ultimately, the U.S. prints its own currency and can choose not to default. 

The bottom line is that those inclined to hedge against worst-case scenarios can take the other side of what the fixed-income market is baking in.

Short-term bonds, which have gained on the idea that rate cuts are happening this year, could be on shaky ground: The Fed showed in 2022-23 that, even when price spikes are supply driven, it prioritizes inflation over growth. 

Conversely, the 2% yield offered by 10-year inflation-protected Treasurys, or TIPS, seems very attractive in a possible future of tepid economic growth and fragmented global supply chains.

To the detriment of stocks, investors may have places to flee after all.