Tag: bonds
Asset Allocation Bi-Weekly – Stopping the Bond Vigilante: How Fiscal Dominance Is Reshaping Global Markets (September 22, 2025)
by Thomas Wash | PDF
The bond bull market that began in the early 1980s lasted nearly four decades. Its longevity was largely built on the assumption that governments would always prioritize the health of their bond markets, even if it meant imposing economic pain on their own countries. This thinking fostered the legend of the “bond vigilante” — a mythical force that would supposedly punish irresponsible government spending by selling off bonds, thereby holding policymakers in check.
The bond market’s core assumption — that it would curb government overspending — has been severely tested since the pandemic. The initial, one-time surge in borrowing was necessary to prevent a global economic collapse. However, that precedent has been exploited. Many governments now use debt to finance a variety of pet projects, from infrastructure and green initiatives to energy subsidies and tax cuts. This increase in spending, detached from any corresponding increase in tax revenue or spending cuts, has been the primary driver behind the recent increase in bond yields around the world (see chart below).
A primary focus of attention is the potential for a supply/demand imbalance in the bond market. The concern is that rising bond issuance is occurring simultaneously, with a shift in investor preferences toward short-duration bonds driven by growing anxieties about inflation, economic growth, and central bank policy. As a result of this mismatch, yields on 30-year government bonds globally have risen to their highest level in over 20 years. This rise in sovereign bond yields is largely attributable to growing concerns over US credit quality, triggered by Moody’s Ratings’ decision to downgrade the US credit rating from Aaa to Aa1 on May 16. The agency justified its move by highlighting the US government’s perceived unwillingness to address deteriorating fiscal conditions, specifically citing structurally large annual deficits and escalating debt servicing costs.
These concerns were compounded by a poorly received 20-year Treasury auction on May 21, which served as an immediate test of market confidence. The auction results were weak, and yields rose above 5% for the first time since October 2023. Although not the sole driver, this weak auction amplified selling pressure across the yield curve, with the 30-year yield surpassing 5%.
Concerns about the US government’s credit quality have also raised fears about the creditworthiness of other developed countries. In the same month that the US had its weak bond auction, Japan also experienced poor demand for a 30-year bond offering. Furthermore, yields have risen across Europe and in the United Kingdom, driven by concerns that these countries may struggle to meet their own budget targets.
On the supply side, although interest rates remain elevated, governments are taking proactive measures to mitigate their impact on the broader economy. Notably, the US, Japan, and the UK have begun increasing their issuance of shorter-duration sovereign bonds. This strategy aims to reduce supply pressure on longer-dated bonds, which helps to curb the rise in long-term borrowing costs. Meanwhile, France is in a debt standoff as it looks to address its budget situation through a combination of spending cuts and tax increases.
On the demand side, most central banks are actively adjusting their strategies to ensure liquidity in the bond market. The Federal Reserve, Bank of England, and Bank of Japan have all focused on modifying the pace of their balance sheet reduction to add liquidity back into the system. While the ECB has not formally stated its intention to use its tools to help bring down yields, particularly in France, it has expressed a willingness to do so through its Transmission Protection Instrument in case of a crisis.
While rising government debt remains a problem, it appears that, at least in the short to medium term, governments have the ability to prevent yields from rising to very high levels. The trade-off is that governments worldwide may remain vulnerable to rollover risk when short-term bonds expire. This could force them to take more proactive measures to prevent rates from destabilizing the economy.
We believe the need to mitigate these fiscal risks could pressure governments into a regime of fiscal dominance, where monetary policy is subordinated to keep public debt servicing costs manageable. A key feature of this environment would be central banks tolerating higher inflation, effectively abandoning their strict price stability and leading to structurally elevated price pressures. In such a scenario, a barbell bond strategy — favoring both short-term and long-term bonds while avoiding the middle of the yield curve — could be advantageous in the near to medium term. Furthermore, peripheral European countries that have demonstrated a credible commitment to fiscal sustainability could become particularly attractive investment opportunities for those seeking international exposure.
Don’t miss our accompanying podcasts, available on our website and most podcast platforms: Apple | Spotify
Confluence of Ideas – #44 “Reviewing the Asset Allocation Rebalance: Q3 2025” (Posted 7/28/25)
Confluence Mailbag – #1 “A Mixed Bag of Bonds, Buffett, Defense & Crypto” (Posted 6/10/25)
Asset Allocation Bi-Weekly – #139 “US Capital Flight and the Implications for Investors” (Posted 5/5/25)
Asset Allocation Bi-Weekly – US Capital Flight and the Implications for Investors (May 5, 2025)
by Patrick Fearon-Hernandez, CFA | PDF
Oh, what a difference one calendar quarter can make! Shortly after Donald Trump was sworn in to his second term as president of the United States, we wrote that the US seemed to enjoy exceptional advantages versus the rest of the world in terms of its economic growth, political stability, and stock market returns. Other economists and market commentators echoed those views. However, just three months into Trump’s new term, many investors seem to be losing confidence in the US’s economic growth and management. As we discuss in this report, the evidence pointing in that direction includes a rise in the yields on US Treasury obligations, a depreciating dollar, and surging gold prices. Below, we discuss these trends and what they may mean for world financial markets going forward.
Reduced Bond Buying / Rising Bond Yields. As shown in the chart on the next page, the yield on the benchmark 10-year Treasury note stood at 4.57% on the first business day after Trump’s inauguration in January. Investors continued to scoop up Treasurys in the weeks following the ceremony, driven by expectations of slower economic growth, easing inflation pressures, and further interest rate cuts by the Federal Reserve. As the administration revealed more about its tariff plans and other aspects of economic policy, growing concerns about the US economy pushed 10-year Treasury yields as low as 4.01% in early April. Since then, however, Treasurys have sold off sharply. Importantly, it appears that foreign institutions in Japan and elsewhere have been a big part of the sell-off. In any case, 10-year Treasury yields have spiked to more than 4.40% since mid-April. The yield on 30-year Treasurys has spiked to as high as 4.91%.
A Depreciating Dollar. Just as US Treasurys have sold off, the dollar has depreciated against many key currencies. The chart below shows the Fed’s nominal US Dollar Index, which tracks the value of the greenback against a broad range of foreign currencies. The broad index shows the dollar has lost about 4.10% of its value since Inauguration Day, with an especially sharp drop since Trump announced the pause in his “reciprocal” tariffs on April 9. The dollar has especially fallen sharply against developed country currencies, such as the euro.
Rising Gold Prices. Rising bond yields and a falling dollar point to falling confidence in the US among global investors, so it should be no surprise that gold — the quintessential safe haven — has appreciated sharply. As shown in the next chart, gold prices have even reached a record high above $3,400 per ounce, with much of the increase coming since early April.
Of course, many long-term investors have been more focused on the recent volatility in US risk assets, especially stocks. In our view, the unique combination of market forces described above may be the more important underlying story. The rise in US bond yields, the decline in the dollar, and the surge in gold represent a rare alignment of market trends that may indicate some measure of capital flight from the US. This pattern of market moves suggests that global and even some domestic investors are trying to cut their exposure to US assets and the dollar. The likely culprit is the administration’s effort to rapidly and fundamentally change the US economic relationship with the rest of the world. As long as that endeavor continues, and investors are unsure of where the to-and-fro of policymaking will take them, these trends are likely to remain in place. Therefore, over the coming months and quarters, the most attractive assets may be much different than what we and other observers had expected at the start of the year. In particular, any continued US capital flight is likely to favor foreign equities, foreign currencies, and gold in the near term.
Don’t miss our accompanying podcasts, available on our website and most podcast platforms: Apple | Spotify
Asset Allocation Bi-Weekly – #134 “Our Take on the Initial Trump Tariffs” (Posted 2/18/25)
Asset Allocation Bi-Weekly – Our Take on the Initial Trump Tariffs (February 18, 2025)
by the Asset Allocation Committee | PDF
While investors broadly understood that the new Trump administration would impose import tariffs as a key part of its economic policy, concrete details weren’t available until the initial tariff announcements on February 1. Even though some of those tariffs were quickly “paused,” the announcements gave us our first chance to explore how the administration intends to wield this weapon against other countries. This report provides our first take on the initial Trump tariff policies. As we show below, we think it’s still too early to gauge the impact that trade policy will have on inflation. What we can say is that the policies are likely to be disruptive for many sectors of the global economy, potentially prompting safe-haven buying in US Treasury obligations and precious metals.
In its February 1 announcement, the administration imposed 25% tariffs on most goods from Canada and Mexico, 10% tariffs on Canadian energy imports, and additional 10% tariffs on imports from China. For legal basis, the White House cited emergency economic authority based on fentanyl trafficking from those countries. Within about 48 hours, however, the administration announced a one-month pause in the tariffs against Canada and Mexico after those countries agreed to minor concessions, such as deploying more troops to their borders with the US to clamp down on illegal crossings and drug shipments. As of this writing, Beijing has made no concessions, so the tariffs on Chinese imports remain in place. At some point, the administration is also expected to impose tariffs against the European Union and potentially against multiple individual countries in Asia and beyond.
Mainstream economists tend to believe that import tariffs are inflationary, at least in the short term, because they can restrict the supply of goods to the domestic market. However, we don’t think investors should blindly assume that’s the case. For many reasons, tariffs may not put much upward pressure on prices. After all, some importers may have little market power and be unable to pass the cost of the tariffs onto their customers. In those cases, the importer would simply suffer lower profit margins. The threat of higher input prices might also discourage firms from investing, reducing overall demand in the economy and potentially offsetting price pressures. The impact on prices would likely differ across industries, depending on how quickly each industry can adjust to the tariffs. Therefore, much depends on whether the tariffs are applied broadly against all imports or targeted against specific trade partners and/or products. Finally, retaliation by the targeted trade partner has to be considered. For instance, countries hit with US tariffs might slap tariffs against US goods, thereby slowing down export growth, increasing domestic supply, and weighing on price pressures. The targeted countries might also impose retaliatory tariffs or embargos on their exports to the US, pushing up inflation.
Nevertheless, although it’s difficult to gauge the impact of tariffs or related trade barriers, the discussion above shows they can certainly be disruptive. Even the modest additional tariffs of 10% against the Chinese, which are already in place, will likely prompt reactions from businesses and consumers, and the net impact of those reactions remains unknowable. Beijing has also already retaliated by imposing tariffs on some US goods, preparing to curb shipments of certain minerals to the US, and ratcheting up regulatory scrutiny of US firms operating in China. For now, we think the main market reaction to the tariffs relates to the potential for economic disruption and uncertainty. In particular, it appears the tariffs have prompted investors to bid up safe-haven assets such as gold, silver, and longer-term bonds.
As shown in the chart below, the yield on 10-year US Treasury notes rose sharply to 4.65% over the first two days after President Trump was inaugurated, when investors were pleasantly surprised by the lack of any immediate tariff action despite the president’s earlier promises. Over the following two weeks, however, as the administration put more of its policies into place and investors could sense the possibility of economic disruptions, they bid up Treasurys, driving down yields. Once the Canadian, Mexican, and Chinese tariffs were announced at the start of February, the flight to safety intensified, pushing Treasury yields even lower to below 4.45%, although they have rebounded somewhat since then.
In the next chart, we show the progression of gold prices over the same period. Here, we see a pullback in gold prices in the period immediately after Trump’s inauguration, when his earliest executive orders and other policy announcements still seemed relatively tame to many investors, reducing the demand for safe-have assets. By early February, once the tariffs were announced, the general uptrend in gold prices re-accelerated, driving prices for the yellow metal to record highs above $2,900 per ounce.
As mentioned, it’s still too early to know whether Trump’s apparently neo-mercantilist economic policy and its associated tariff program will be inflationary. However, it does seem clear that investors are focused on the risk that the tariffs will drive prices higher and the potential for them to create economic disruptions. Investors are therefore bidding up traditional safe-haven assets, including longer-term Treasury obligations and gold. If and when the administration applies tariffs to the EU or other economies, we suspect longer-term Treasurys and gold could see another round of safe-haven buying. Based on technical analysis, we think the yield on the 10-year Treasury could be pushed down to its next major support level at about 4.17%, while gold could be pushed higher to its next expected resistance levels of $3,000 or $3,100 per ounce. Treasurys and gold could continue to be well bid until investors sense that the international trade environment has stabilized.