U.S. bond market turmoil signals technical stress, not fundamental shift 

Stephen Dover

Following a sharp retreat in both U.S. and global equity markets, another pillar of the financial system has come under pressure: the U.S. bond market. In a matter of days, the yield on the benchmark 10-year U.S. Treasury has surged by nearly 50 basis points, raising alarm bells across Wall Street.

However, Stephen Dover, Chief Market Strategist and Head of Franklin Templeton Institute, believes the market turmoil may not be rooted in fundamentals, but rather in technical dislocations.

“This spike in yields appears to be more technical than fundamental,” Dover said. “We begin with the facts. Long-term Treasury yields are rising sharply and much faster than short-term yields, leading to a steepening of the yield curve. Why is that happening? In theory, various factors could be behind the jump in bond yields. It might be that investors are worried about inflation, insofar as tariffs will boost US inflation. It could be that investors are worried about large US budget deficits and debt levels. Or it could be that investors are concerned that countries hit by tariffs, such as China or Japan, might stop buying Treasuries or even might sell their massive stockpiles of them.”

The move has steepened the U.S. yield curve significantly, as long-term yields have risen much faster than short-term rates. That kind of curve steepening typically suggests rising growth or inflation expectations. But Dover says neither is supported by the data.

“None of those reasons is, for now, compelling. Measures of expected inflation (based on Treasury Inflation Protected Securities or TIPS) do not evidence a sharp increase in investor expectations. As of April 8, the 10-year breakeven inflation rate from TIPS pricing is a subdued 2.22%. Deficits and debt expectations have not materially worsened. If anything, the tax revenues from tariffs represent fiscal tightening and the odds of the Tax Cuts and Jobs Act of 2017 being extended, and even a large tax cut this year, have not materially changed.

“Finally, if foreign central banks and reserve managers were slowing their purchases of Treasuries, the US dollar would be selling off in tandem with the bond market. While the dollar has softened a bit, it does not appear to be under similar selling pressures.

“The probabilities therefore suggest that leveraged positions in Treasuries (including basis trades or positions in swap markets) are the source of this week’s selling pressures. Of itself, that could be benign—or possibly not. If the selling pressure is contained, we believe little damage will be done. If, on the other hand, one or more financial institutions has gotten “over its skis” and is selling under duress, the Fed might deem it necessary to prevent further financial dislocations.

“However, the Fed’s engagement would probably not be via interest rate cuts, but rather via commitments to provide targeted liquidity.

“Finally, rising long-term interest rates, if sustained, represent a further tightening of financial conditions beyond declines in global equity markets or widening of credit spreads. In that regard, we think they represent a further risk to the outlook for US and global growth and corporate profits.”

In the short term, markets may remain choppy as technical factors work their way through the system. But for now, Dover is urging investors to focus on signals, not noise.

“We’re closely monitoring the situation,” he concluded. “But at this point, the evidence points to technical pressure and not a broader shift in economic outlook.”