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 a temporary suspension of "reciprocal tariffs," the U.S. stock market has largely recovered its losses, but the bond market has yet to "heal."

Statistics show that the S&P 500 index has recorded gains on 15 out of the past 22 trading days and has now returned to levels seen 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 exhibited the same optimism. The yield on the 10-year U.S. Treasury bond has fallen from a peak of 4.492% in April 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 outlooks, and Federal Reserve expectations.

As Thomas Mathews, head of Asia-Pacific markets at Capital Economics, stated: "The Treasury market has not fully healed yet." 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 rates. Consequently, they demand higher yields to bear the risks of holding U.S. Treasuries 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 average of 0.37% in March.

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 Treasuries due to concerns about increased bond supply needed to finance the federal budget deficit. Republicans have been working on significant tax reduction legislation for months, but it remains 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 U.S. 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, the global interest rate strategist 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

With short-term U.S. Treasury yields falling, the 10-year U.S. Treasury yield is rising, 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 bond. 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, the concern is that they may not decline significantly, keeping mortgage and other types of debt rates high when the central bank hopes to encourage borrowing.

According to Freddie Mac data, 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 recession.

Risk Warning and Disclaimer

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