Bond Selloffs Are Rocking the World. It Might Be a Good Idea to Go the Other Way

Wall Street's apprehension over bonds is intensifying, but this might be the right moment to consider investing in them.

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A surprisingly robust jobs report has driven yields on 10-year Treasurys to close at 4.772%, their highest level since November 1, 2023, while 30-year yields reached 4.962%. These elevated yields are rattling markets, not because they indicate stronger economic growth, but due to other underlying factors.

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Federal Reserve estimates suggest the increase in yields stems largely from investors demanding a higher discount or “term premium” to hold long-term bonds. Analysts point to several drivers of this shift, including fears that potential tariffs promised by Donald Trump could disrupt the global economy, trigger inflation, and exacerbate budget deficits through tax cuts.

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The effects of these rising term premiums are rippling across global markets, with weaker economies feeling the pressure most acutely. In the U.K., 30-year bond yields have surged to approximately 5.4%, marking a 27-year high. U.K. Treasury chief Rachel Reeves faces mounting pressure as she attempts to balance appeasing bond markets with modest growth ambitions in her latest budget. Similarly, France finds itself in a precarious position. Political gridlock has hindered effective governance, and the country’s borrowing costs have now surpassed those of Greece.

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Currency markets are also showing signs of strain. The British pound and the euro are weakening, with the euro nearing parity with the U.S. dollar. Stock markets are mirroring these challenges, with the S&P 500 and Europe’s Stoxx 600 falling by 1.5% and 0.8%, respectively, at the close of trading on Friday. Despite the turbulence, bonds might paradoxically offer a safe haven in these uncertain times.

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To understand why bonds could be a refuge, it’s essential to consider the unusual macroeconomic environment. Central banks have aggressively raised interest rates without severely harming economic growth and are now signaling cautious rate cuts while maintaining hawkish rhetoric.

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This rare combination has created a landscape where fixed-income investors are dismissing the risk of a “hard landing” for the economy. Convinced that cash returns won’t fall below 3.5% anytime soon, these investors are demanding greater compensation for locking their money into long-term bonds.

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This increased term premium remains modest by historical standards. It currently adds around 0.6 percentage points to 10-year yields, compared to the historical average of 1.5 percentage points. Additionally, the yield curve’s steepness is mild when viewed in a historical context. Still, the rising term premium is reshaping investment dynamics, particularly in equity markets.

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Friday’s sharp decline in stock markets can be partly attributed to high valuations. After years of technology-driven market rallies, the S&P 500 has become significantly overvalued. Even under optimistic forecasts for 2025, the index’s forward earnings yield has dropped to 4.6%, roughly equal to the yield of a 5-year Treasury. This parity highlights why bonds are increasingly viewed as a competitive alternative for medium-term investments, drawing attention away from equities.

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The outlook for bond yields remains uncertain. Yields could rise further, potentially exerting downward pressure on economic growth, especially in international markets. Elevated borrowing costs could weigh on global economies, amplifying the challenges faced by countries like the U.K. and France.

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Should economic growth falter significantly, however, central banks would likely pivot toward stimulus measures. This shift would involve cutting interest rates and potentially reintroducing quantitative easing to support economic activity. Such a scenario would likely benefit bonds, as declining rates boost bond prices and deliver solid returns for investors.

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In summary, while rising yields and term premiums are currently unsettling global markets, bonds might emerge as a resilient asset class amid this volatility. For investors seeking stability, particularly in the face of potential economic headwinds, bonds offer a compelling option. Their role as a hedge against central bank policy shifts and broader market turbulence reinforces their appeal as a cornerstone of diversified investment strategies.

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