Tim Murray:

U.S. Treasuries historically have tended to perform well when recession concerns were rising. However, that hasn’t been the case during the most recent equity market sell-off. Investors may need to consider alternative ways to seek shelter from the storm.

When stock prices fall sharply, U.S. Treasuries historically have tended to rally. This is because an equity market sell-off often signals a looming economic slowdown―or, in some cases, an outright recession.

Investors know that when the economy goes into recession, the U.S. Federal Reserve usually responds by cutting interest rates. Other things being equal, lower interest rates tend to push up U.S. Treasury prices. 

However, that has not been the case during the recent tariff-related market slump.

In the three most recent equity bear markets, returns on longer-term U.S. Treasuries were sharply positive:

In the bear market that ran from March 24^th, 2000, to October 9, 2002, the Bloomberg U.S. Long Treasury Index returned a positive 38% while the S&P 500 Index lost 47%. 

In the bear market from October 9^th, 2007, to March 9, 2009, long Treasuries returned 21% while the S&P 500 lost 55%.

And during the bear market from February 19, 2020, to March 23, 2020, long Treasuries posted a 13% gain while the S&P 500 lost 34%. 

By contrast, in the sell-off that began on February 19^th of this year, long Treasuries posted a negative 1.4% return through April 21^st—even as the S&P 500 lost 15.9%.

One reason for the surprising performance by U.S. Treasuries is that higher tariffs potentially put the Fed in a very difficult position.

The Fed has a dual mandate: One priority is to support the U.S. economy and keep unemployment low. The other is to hold consumer inflation to a stable and sustainable level—typically defined as 2%. But a sharp rise in tariff rates poses serious risks to both objectives. Higher tariffs are likely to weaken U.S. economic activity, but also threaten to push prices higher.

As a result, the Fed may be less willing to stimulate the economy by cutting interest rates if it fears that inflation could get out of control. 

This is, in fact, what the federal funds futures market is telling us. Despite growing concerns about the economic impact of higher tariffs, futures contracts so far have not priced in expectations for a sharp decrease in the federal funds rate—the Fed’s key policymaking rate.

As of April 21^st, the futures market was pricing in four 25 basis point cuts in 2025 and only one additional cut in 2026. This would take the fed funds rate to a lower level than what was expected before President Trump’s April 2^nd tariff announcement—but not dramatically lower.

In fact, fed funds would still be higher than what futures markets were pricing in on December 31^st, 2023, when recession concerns were relatively low.

It is also notable that while fed funds expectations fell slightly in April, the U.S. Treasury 10-year yield actually rose slightly. This reflects a rise in what is known as the term premium—the yield over and above the rate priced into fed funds futures. This additional yield compensates investors for the risk that rates will go considerably higher than expected. 

The term premium has risen dramatically over the past year, and most dramatically over the past month. While it is hard to know precisely what has driven this move, possible reasons include foreign entities reducing their U.S. Treasury holdings, higher uncertainty about future Fed policy, and concerns about the enormous U.S. federal budget deficit.

All three of these factors likely have been magnified by a sharp rise in U.S. economic policy uncertainty as investors try to understand how the tariff wars will play out. So, we can conclude that U.S. Treasury prices are probably behaving abnormally due to a combination of monetary and broad economic policy uncertainty.

Given the abnormal behavior of U.S. Treasuries in the face of rising economic risks, non-U.S. government bonds could be an alternative for investors seeking less-volatile assets. This is because central banks in other developed market countries may be less conflicted about cutting rates to fend off economic weakness. Additionally, economic policy in most other nations appears less uncertain compared to the U.S., so a rising term premium may be less of a concern.

Thus far, this dynamic has meant stronger bond returns in non-U.S. markets during the recent equity sell-off. From February 19^th to April 21^st, the Bloomberg Global Aggregate ex-USD Index returned 7.08%, while the Bloomberg U.S. Aggregate Index returned just 0.54%.

The potential for a tariff-related conflict between the Fed’s two main policy goals—supporting employment and controlling inflation—means that U.S. Treasuries have not been as attractive in the recent equity market downturn as they were in past sell-offs. As a result, T. Rowe Price’s Asset Allocation Committee recently moved to an overweight position in international developed market bonds.