Insights on the U.S. Bond Market

By Davide Barbuscia
NEW YORK (Reuters) – Some investors see potential cracks in the U.S. bond market and red flags from recent whipsawing moves, claiming that the market underprices long-term fiscal risks and the danger posed by White House pressure on the central bank to cut interest rates.

U.S. bond markets sold off earlier this week as global fiscal health concerns escalated, though the pain was quickly reversed and bonds rallied on weak economic data. The rebound continued on Friday, as a sharp slowdown in U.S. job growth raised the prospect that the Federal Reserve would embrace a faster pace of monetary easing than anticipated.

Investors, however, say they remain concerned about the health of the market.

“My concern is that we’re in a bit of a boiling-the-frog moment,” said Bill Campbell, portfolio manager for global bond strategy at DoubleLine, referring to the risks of institutional strength erosion, particularly from recent pressure from the White House on the Fed to lower interest rates, along with a worsening U.S. fiscal trajectory.

Some measures of risk in the bond market show that investors are accounting for an overly dovish Fed that could lead to higher inflation down the line. The U.S. Treasury term premium, which measures the compensation for the risk of holding long-term U.S. debt, rose to 84 basis points on Tuesday, its highest level in over three months, according to New York Fed data.

Expectations for inflation over the next decade, as assessed by Treasury Inflation-Protected Securities (TIPS), hit 2.435% on August 27, the highest level in more than a month. These expectations have since declined and last stood at 2.36% on Friday.

“I’m wondering if what we’re seeing with the continuation of the widening in term premium is just more like cracks in the dam,” Campbell said.

Market participants find it hard to isolate the drivers behind the recent market movements. Factors include pressure on the Fed, the inflationary impact of tariffs, U.S. debt trajectory, and rising global debt levels.

These issues support trades that bet on a steeper yield curve, where long-term debt becomes less attractive compared to short-dated securities. A steepening curve indicates investor anticipation of higher interest rates in the future due to strong economic activity and higher inflation.

Jonathan Cohn, head of U.S. rates desk strategy at Nomura, noted that the market has been relatively calm regarding pricing these risks but acknowledged the complexity in deciphering them.

Donald Trump has criticized Fed Chair Jerome Powell and the central bank for not lowering rates enough, raising concerns about political pressure affecting monetary policy. While calling for aggressive rate cuts, Trump also stated the Fed might raise rates if inflation rises.

White House spokesperson Kush Desai stated that Trump believes it is time to cut rates to support employment and economic growth, especially following the recent slowdown in job growth.

DoubleLine’s Campbell warned that pushing for lower rates might backfire by increasing long-term yields, a critical factor in borrowing costs for consumers, such as mortgages and credit card rates.

Trump will soon have the chance to nominate a replacement for Powell, whose term expires next May. He has already nominated Stephen Miran for the Fed’s board and attempted to remove Fed Governor Lisa Cook over alleged mortgage fraud, prompting legal action from Cook.

Lawrence Gillum, chief fixed income strategist for LPL Financial, expressed concern that potential excessive influence from the executive branch over interest rate decisions might increase term premiums and steepen yield curves.

“I think we’re in the early phases of the bond market kind of trying to figure out what this is going to look like,” Gillum said. “It’s really too early to make any sort of proclamation just yet.”