Wealth Insights

Bonds Commentary

Bonds: Treasury Rally Runs Out Of Steam

April 2025

U.S. Treasury bonds traded in a narrow range throughout March as a battle between market participants buying bonds in preparation for an economic slowdown and those more concerned that inflationary pressures would return as reciprocal tariffs were enacted continued to play out. Yields on Treasury bonds maturing inside of 10-years fell modestly during the month with the 2-year Treasury yield, specifically, declining from 3.99% on February 28 to 3.89% on March 31. Farther out on the yield curve, the 10-year yield closed out the month a single basis point lower at 4.23% but fell through the floor in early April as the tariff framework was released, with the 10-year trading hands with a yield below 4% early in the month. All told, the Bloomberg Aggregate Bond index ended the month with a meager 0.04% gain but closed out the quarter with a respectable 2.7% total return as the asset class has provided diversification benefits and a buffer against an equity market drawdown as volatility has ramped up amid elevated economic uncertainty.

One quarter and a few weeks into the new year, yields on long-dated U.S. Treasuries have been on a roller coaster ride. The 10-year U.S. Treasury yield ran up to 4.80% in mid-January as pro-growth policies out of the new administration were priced in but dropped sharply from mid-February into the April 2 tariff announcement as trade uncertainty led to fears of an economic slowdown. On the heels of the tariff announcement, yields on long-dated Treasuries have risen sharply with the 10-year closer to 4.40% as market participants have grown concerned that our trading partners will balk at buying our bonds as they demand fewer U.S. dollars and U.S.-dollar denominated assets if export volumes to the U.S. fall in a material way. Tariffs being levied on a broad swath of U.S. imports is expected to put upward pressure on inflation, but corporations and consumers reigning in investment and spending in the face of policy uncertainty will contribute to economic growth concerns and likely keep a bid under high quality, shorter-dated bonds as market participants value capital preservation over potential appreciation.

Our base case has called for long-dated U.S. Treasury yields to remain rangebound with the 10-year yield likely finding sellers around 4.00% and buyers closer to 4.50%. Prior to the April 2 tariff announcement, economic growth concerns and inflation fears were largely in equilibrium, offsetting one another and bringing some relative calm to the Treasury market. But that dynamic has shifted, and investors appear increasingly concerned that inflation is going to rise materially at a time when demand for Treasuries could dry up. With the U.S. and trading partners such as Japan, South Korea, and the U.K. expected to come to the bargaining table in the near-term, concerns surrounding foreign demand should ease somewhat, but the process of negotiating with over 60 countries will be painfully slow, and with the FOMC likely to remain on the sidelines in May and perhaps longer due to persistently sticky inflation, downside for Treasury yields could be limited.

High-Grade Preferred Over High Yield At Present. March was a difficult month for riskier segments of the fixed income market as high yield corporate bonds lagged their investment grade counterparts by 1.4% as valuations cheapened and credit spreads widened across the quality spectrum. The sharp rise in equity volatility driven by trade policy uncertainty and its potential downstream economic impacts have forced credit spreads wider for high yield bonds by 80-basis points in April as of the time of this writing to 4.25% above similar maturity Treasuries, and the Bloomberg U.S. Corporate High Yield index now yields 8.30% after falling 0.7% year-to-date. Objectively, high yield credits are getting cheaper but may not yet be cheap enough to fully account for the rising economic risks facing investors. Historically, riskier credits tend to participate in selloffs once U.S. equities fall over 5% and the CBOE Volatility Index (VIX) rises sharply, but to this point the sell-off in credit has been fairly contained and almost orderly.

The improved credit quality of the sub-asset class certainly plays a role in more muted volatility for high yield bonds, but ultimately this is a risk asset that allocators and institutions typically lighten up on when the economic backdrop worsens and loss aversion bias creeps in. That opens high yield bonds up to greater downside participation now that markets have started to more appropriately bake in the gravity of current circumstances. On the other end of the credit spectrum, investment grade corporates still offered investors a 5.3% yield-to-worst in early April, and, for now, the deck is stacked in favor of investment grade credit. But if volatility persists and stocks pull back further, forcing high yield bonds to trade at deeper discounts with credit spreads surpassing landmarks like the 10-year average option-adjusted spread of 412-basis points, investors and allocators could find a yield-to-worst approaching 9% on high yield bonds too juicy to pass up, assuming a deep and protracted recession isn’t the base case.

As of April 9, 2025