Trump's "Major Concern": The Stock Market is Back, but Bonds are Not

Discrepancies emerge in the U.S. stock and bond markets: Since Trump announced the postponement of "reciprocal tariffs," the U.S. stock market has largely recovered its losses, but the bond market has yet to "heal."

According to statistics, the S&P 500 index has recorded gains on 15 out of the past 22 trading days and has now returned to the levels before the tariff shocks in April.

Reports indicate that this rebound occurred while Trump still maintains a 10% tariff on most countries. However, aside from reaching a trade agreement with the UK and meeting with Chinese officials, there has been little substantive progress in trade negotiations.

However, bond investors have not shown the same optimism. The yield on the 10-year U.S. Treasury bond has fallen from an April peak of 4.492% to 4.374% last week, currently reported at 4.406%. Yet, it remains above the 4.156% level prior to the tariff announcement in April and the average of 4.276% from the previous month.

The yield on the 10-year U.S. Treasury bond has not returned to pre-tariff shock levels, and the term premium remains high, indicating that the market is still digesting the uncertainties surrounding tariff policies, fiscal outlook, and Federal Reserve expectations.

As Thomas Mathews, head of Asia-Pacific markets at Capital Economics, stated: "The Treasury market has not fully healed." Goldman Sachs analysts wrote in a recent report that the macroeconomic uncertainties in the fundamentals are unlikely to be resolved merely through a change in rhetoric.

Multiple Factors Intensify Pressure on the Bond Market

The caution in the bond market reflects multiple concerns. First is the inflation uncertainty brought about by tariff policies.

Reports indicate that Trump's erratic trade policies have weakened investors' confidence in predicting future inflation and interest rate trends. As a result, they demand higher yields to bear the risks of holding U.S. Treasury bonds for the long term.

This additional compensation is known as the term premium, which measures the extra yield that investors require for taking on the risk of locking up funds for an extended period.

Market data shows that the latest term premium for the 10-year Treasury bond is 0.69%, close to the peaks of 0.84% and 0.78% in April, and significantly higher than the March average of 0.37%.

Thomas Mathews stated:

"This risk premium may take some time to fully dissipate, as its roots lie not only in the tariffs themselves but also in the unpredictable manner of their announcement and implementation."Secondly, investors are hesitant to purchase long-term government bonds due to concerns about an increase in bond supply needed to finance the federal budget deficit. Republicans have been working on significant tax reduction legislation for months, but it is uncertain whether it will include substantial spending cuts.

In addition, the White House's criticism of the Federal Reserve's interest rate policy has also had an impact. Wall Street Journal previously mentioned that President Trump has repeatedly called for Powell to cut interest rates, and after the Federal Reserve held steady in its recent rate decision, Trump once again criticized Powell.

Multiple factors such as inflation, deficits, and policy interventions have not only intensified pressure in the bond market, particularly affecting the long-term U.S. Treasury market, but have also led major Wall Street banks to raise their yield expectations for 10-year U.S. Treasuries.

Jay Barry, head of global interest rate strategy at JP Morgan, raised the expected low point for the 10-year yield from the previous 3.65% to 3.9% last week, with a baseline forecast still at 4%, consistent with UBS. Capital Economics' year-end forecast is 4.5%.

Tim Ng, a fixed income portfolio manager at Capital Group, stated that the bond market reflects uncertainty about the direction of the economy and ongoing uncertainty about how the policy environment will ultimately play out.

This is an unusual and dangerous phenomenon in the U.S. Treasury market

In the context of falling short-term U.S. Treasury yields, the 10-year U.S. Treasury yield has risen, and the term premium remains high. This rare divergence, referred to in Wall Street terminology as "steepening inversion," is an unusual and dangerous phenomenon that has begun to challenge policymakers and push up consumer borrowing costs.

Typically, U.S. Treasury yields are strongly influenced by investors' expectations of the average level of short-term rates set by the Federal Reserve over the life of the bonds. However, the connection between long-term yields and this outlook has weakened, which may make it more difficult for the Federal Reserve to stimulate growth through interest rate cuts.

Most investors and analysts believe that if the U.S. falls into recession this year and the Federal Reserve significantly cuts rates, long-term yields may still decline. However, there are concerns that they may not drop significantly, keeping mortgage rates and other types of debt high when the central bank hopes to encourage borrowing.

According to Freddie Mac, the average rate for a 30-year fixed mortgage last week was 6.8%, slightly up from a month ago.

It is worth noting that investors may view a 10-year yield between 4% and 4.1% as a signal of easing concerns in the bond market, but if yields return to the 3.8% range, it may trigger renewed worries about a recession