Wall Street is really worried about bonds. It might be time to buy some.
On Friday, a jobs report that blew past expectations pushed yields on 10-year Treasurys to 4.772%, the highest close since Nov. 1, 2023, and those on 30-year paper to 4.962%.
What is spooking markets, however, is that much of the recent rise in yields doesn’t appear to reflect expectations of stronger economic growth. Rather, it might be the result of investors applying a higher discount or “term premium” to hold long-term bonds, estimates by the Federal Reserve suggest. Some analysts attribute this to the possibility of Donald Trump’s promised tariffs derailing the global economy and leading to a jump in inflation, while his tax cuts bloat budget deficits further.
Movements in term premiums are usually strongly correlated across the globe, and the consequences are being felt more starkly in weaker economies overseas, especially in Britain. There, 30-year yields are trading around 5.4%, a 27-year high. U.K. Treasury chief Rachel Reeves, who has made a public pledge to appease bond markets while also attempting to set out some moderate growth ambitions in her latest budget, is under strong pressure.
France is also in the hot seat: The government is shackled by a parliamentary deadlock and now has borrowing costs firmly above those of Greece.
In a further sign of trouble, the pound and the euro are falling, with the latter sliding close to parity with the U.S. dollar. The S&P 500 and the Stoxx Europe 600 ended Friday down 1.5% and 0.8%, respectively.
But counterintuitively, bonds may ultimately prove to be the safest place amid the storm.
For one, the fiscal doomsayers are probably wrong: Countries that print their own currency can’t truly be pushed to default. More importantly, inflation-linked Treasurys have sold off too, belying the idea that markets see a hot economy and tariffs as a serious inflationary problem.
It might all have to do with interest rates after all. Since December, the Fed has squashed expectations of a prolonged rate-cutting cycle. As a result, the whole middle part of the Treasury yield curve—from two to five-year maturities—has become positively sloped for the first time since 2022. Only the very short end, from three months to one year, remains inverted, reflecting the one or two cuts that markets suggest might still happen this year.
The reason alarm bells are ringing is that longer-term bonds have sold off even more—a “bear steepening” trade, in Wall Street lingo. Three out of four times, yield curves steepen for the opposite reason, historical data shows: a fall in short-term yields driven by central banks cutting rates very fast. Bear steepenings following a period of inverted yield curves are rare and mostly are reminiscent of the “stagflation” periods of the 1970s and 1980s.
But this gets to the core of the matter. Today’s situation, in which central banks have been able to aggressively raise rates without harming the economy and then slowly cut them while launching hawkish messages, is nearly unprecedented.
Keeping this in mind, what is happening to bonds makes sense. Fixed-income investors have ruled out a “hard landing” for the economy and have been persuaded by officials that returns on cash probably won’t dip below 3.5% for the foreseeable future. They have thus started demanding a larger reward to lock up their money for longer.
This term premium still isn’t huge: It is reportedly adding 0.6 percentage point to 10-year yields, when the historical average is 1.5 percentage points. The steepness of most of the yield curve remains mild by historical standards.
So why did stock markets react so negatively on Friday? One key factor might be stretched valuations. After years of technology-led rallies, the S&P 500 has become so expensive that, even if analysts’ optimistic outlook for 2025 is realized, its one-year forward earnings yield has fallen to 4.6%—the same as the yield of a 5-year Treasury. This explains why equity holders are increasingly seeing bonds as competition, especially for medium-term investment horizons.
To be sure, this doesn’t rule out the possibility that yields could rise further or that high yields themselves could have a negative impact on economic growth, especially abroad.
Were growth and corporate earnings to truly suffer, though, central banks would need to change course and go into stimulus mode. Guess which asset class gains in that scenario: Bonds.
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