Last week, U.S. Treasuries showed early signs of regaining their safe-haven appeal. Investors who had heavily bet on continued bond market declines this year may now face a covering test.
As market concerns escalated over the outlook for leading artificial intelligence (AI) companies and their potential impact on the broader economy, the 10-year Treasury yield fell approximately 17 basis points last week, while the Nasdaq 100 index plunged 5.5% during the same period. The last time the 10-year Treasury yield and the Nasdaq 100 index experienced such significant simultaneous declines in the same week was during the tariff turmoil in April 2025.
This bond market rally is noteworthy because for months prior, Treasuries had failed to provide effective safe-haven protection when stocks came under pressure. Elevated inflation, ongoing economic resilience, and heavy government and corporate debt issuance鈥攊ncluding financing for the AI boom鈥攈ad collectively pushed the 10-year Treasury yield to its highest level in over two decades over the past seven months.
The latest round of stock market volatility broke that trend. Part of the reason is that investors had held unusually aggressive bearish Treasury bets, increasing the likelihood of short covering鈥攚here bears buy back bonds to close positions, thereby pushing prices higher. Even with inflation still stubborn, the risk of two-way volatility in the bond market is rising. Marlborough Investment Management portfolio manager James Athey said: "To paraphrase Mark Twain, rumors of the death of Treasuries have been greatly exaggerated."
Safe-haven flows return to Treasuries as tech stocks tumble
Of course, it is still too early to declare that the AI boom is about to end. Previous rounds of market volatility also proved relatively short-lived. However, signs of slowing revenue growth at Anthropic PBC and declining bond prices at AI cloud computing service provider CoreWeave Inc. have led the market to question whether the AI trade that helped drive the bond selloff is now showing cracks.
Massive AI investment has boosted the economy, while surging demand for computer chips has intensified inflationary pressures.
AI trade shows cracks, Treasury safe-haven value draws renewed attention
Julius Baer fixed income strategist Afonso Borges wrote in a report that "an AI-induced recession would be closer to a traditional negative demand shock" and could become a catalyst for deflation. He stated that in such a scenario, "intermediate-term Treasuries should once again play an effective portfolio hedging role." Against this backdrop, the institution recommends adding duration with longer-dated bonds in the intermediate term.
Borges noted that during stock market drawdowns from 2000 to 2020, 10-year Treasuries consistently delivered positive returns. Heavy corporate debt issuance to finance AI infrastructure has intensified competition for capital, becoming another headwind for Treasuries. If AI investment expectations fade, the impact of these factors could reverse.
Investment-grade companies, led by mega-cap tech firms, have issued approximately $1.7 trillion in bonds this year, up about 29% from the same period last year. Natixis North America head of U.S. rates strategy John Briggs said: "If investors see AI-related bonds depreciating, their willingness to buy new debt will decline. Therefore, in the short term, the issuance channel for AI bonds has narrowed somewhat, and as a result, investors are buying more long-term U.S. Treasuries because concerns about crowding out have diminished."
If the AI trade continues to weaken, trader position adjustments could also amplify bond market gains. The Treasury rally was boosted by commodity trading advisors (CTAs, trend-following funds) exiting bearish futures positions; these investors were extremely bearish when building positions last week.
Safe-haven buying pushes Treasuries higher, but inflation and oil prices remain variables
Safe-haven inflows helped ease the pressure on bonds from persistent inflation. Last week's higher-than-expected consumer price data initially prompted traders to increase bets on a Federal Reserve rate hike this month, with the probability briefly rising to about 50%. But as the stock market selloff intensified, the market's perceived probability of an October rate hike declined.
Federal Reserve Chairman Kevin Warsh spoke at the International Monetary Fund annual meeting, making no comments on monetary policy or the economic outlook beyond reiterating that the Fed will maintain price stability, further reducing the likelihood of a rate hike. Traders still expect the Fed to raise rates once by year-end and once more in 2027.
Given these expectations, Standard Bank G10 strategy head Steven Barrow called the recent bond rally a "sleight of hand." He noted that future inflation risks remain, and market structure is shifting toward favoring equities and moving away from sovereign bonds. Friday's oil price surge also showed that bonds' role as a hedging tool can easily be upended.
Oil prices had already risen sharply during the Iran war and exacerbated inflation concerns. Due to market doubts about President Trump's agreement to release more Russian diesel into global markets, crude oil prices rose, and U.S. Treasuries and stocks weakened in tandem around midday.
Looking ahead, State Street Investment Management senior fixed income strategist based in Tokyo Masahiko Loo said the uncertainty created by Warsh's lack of forward guidance鈥攁 core principle of his monetary policy approach鈥攎akes the market more susceptible to large price swings. However, Loo said that for long-term investors, "the situation is different." "If a larger AI-driven risk-off episode occurs, Treasuries appear increasingly capable of providing the hedge that investors have been missing for most of the past few years."
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