U.S. government bonds have moved sharply in a way that challenges a long-held market assumption: that high-quality debt protects portfolios when equity markets fall. Since the outbreak of the Iran war, long-dated Treasuries have come under selling pressure as investors push for higher compensation to account for inflation risks, resilient U.S. economic activity and expectations of heavier Treasury issuance tied to deficit spending.
Demand for higher yields was evident this month when the 30-year U.S. Treasury yield climbed further above 5% than analysts had expected before buyers returned to the market. At the same time, the 60-day correlation between S&P 500 returns and Treasury returns has reached its highest level in more than 20 years, a signal that bonds are moving more in step with stocks and, in some cases, amplifying swings rather than offsetting them.
That shift strikes at the heart of the classic 60/40 portfolio approach, which counts on fixed income to provide both income and a diversification hedge against equity downturns. Typically, Treasury prices rise when stocks fall - a negative correlation that cushions losses. "The value proposition of bonds in a portfolio is really quite challenged with the negative bond-equity correlation non-existent," said Jonathan Cohn, head of U.S. rates desk strategy at Nomura.
How the dynamic changed
Market participants trace the problem back to 2021, when inflation surged amid disruptions from the COVID period. The dynamic has returned with added force more recently as oil prices climbed following the Iran war, reinforcing concerns that inflation may remain above central bank targets. That concern reduces the scope for policymakers to ease monetary policy if growth begins to soften, and it keeps investors wary of holding long maturities.
For many portfolio managers, the unsettling element is not solely the absolute level of yields but what the move implies about fixed income's role as a stabilizer. "Bonds aren’t going to necessarily hedge your portfolio when inflation is high and volatile," said John Luke Tyner, head of fixed income and portfolio manager at Aptus Capital Advisors.
Fiscal pressures and term premium
Beyond inflation and growth, fiscal considerations are exerting further pressure on the long end of the yield curve. Investors are increasingly sensitive to the cost of servicing U.S. debt, the prospect of additional Treasury issuance and the possibility that ongoing deficits will require a higher term premium - the extra yield demanded to hold longer-dated bonds amid greater perceived risk.
That premium has widened notably: the term premium on 10-year Treasuries recently reached about 0.86%, after having fallen below 0.50% in February, reflecting a substantial change in the compensation investors seek for duration risk. "There are certainly more questions about the safety of the dollar and U.S. deficits than there were five years ago," said George Catrambone, head of fixed income for the Americas at DWS Group.
Still a core asset, but with a different playbook
Despite these headwinds, most investors are not prepared to abandon Treasuries as a core global asset. The U.S. bond market remains the deepest and most liquid in the world, and that liquidity underpins continued demand. For many managers, the current debate is not about whether to own Treasuries but about which parts of the curve to favor.
Both Catrambone and Cohn have signaled a preference for shorter maturities amid the uncertainty. "I don’t think this is the death knell of the dollar or the Treasury," Catrambone said. "I think actually Treasury yields are attractive as a way to start to get back in and diversify your portfolio."
By contrast, the calculus for longer-dated bonds appears to be changing. In a setting of sticky inflation, persistent fiscal strain and volatile policy expectations, long bonds may need to offer higher yields than in the past to lure buyers away from riskier but higher-paying assets such as equities.
That dynamic is further complicated by investor enthusiasm for corporate profit and growth tied to heavy spending on artificial intelligence. Market participants are pricing in more aggressive growth and earnings expectations as companies invest record amounts in AI, increasing the opportunity cost of holding long-duration Treasuries.
Some portfolio managers express the trade-offs bluntly. "Bonds are certificates of confiscation in terms of your real purchasing power," said Tyner. "On the other hand, everyone’s looking at stocks and asking why they don’t own those - they’re going up 20% a year."
Implications for investors
The current environment is prompting reassessment of duration exposure and the role of fixed income in portfolio construction. While Treasuries remain a central and liquid asset class, the conditions that historically allowed long-term government bonds to act as an automatic hedge against equity weakness have been weakened by the interaction of inflation risks, fiscal outlooks and shifting market expectations.
That has left many investors weighing shorter maturities and re-evaluating how much long-duration exposure is appropriate, even as they continue to recognize the practical benefits of holding U.S. government debt.