Major bond fund managers on Wall Street are betting that the market is severely underpricing the risk of a U.S. economic slowdown. The unusual drop in U.S. Treasury yields last Friday might signal that this logic is beginning to play out.
Amid the ongoing U.S.-Iran conflict and oil prices surpassing $110 per barrel, the U.S. bond market experienced its worst monthly decline since October 2024. However, market dynamics shifted significantly last Friday. Despite rising oil prices and a sell-off in U.S. stocks, Treasury yields did not follow their usual upward trajectory. Instead, they fell noticeably, marking a rare decoupling from conventional market logic.
According to a report on the 30th, institutions such as JPMorgan Asset Management and Pacific Investment Management Company (Pimco) believe the core narrative driving the current bond market sell-off—that inflation shocks will force the Federal Reserve to raise interest rates—is obscuring a deeper risk. They argue that the combined effect of soaring energy prices and rising borrowing costs will ultimately evolve into a growth shock, which would then force Treasury yields lower. For these institutions, the current high yield levels present a strategic entry point.
**Inflation Narrative Dominates, Growth Risks Underestimated**
Since the U.S. launched military strikes against Iran, traders' attention has been almost entirely focused on the inflation shock. With oil prices continuing to climb, the OECD warned last week that U.S. consumer prices could rise by 4.2% this year. This expectation has driven investors to demand higher yield compensation to protect against inflation's erosion of real returns. The yield on the 30-year Treasury has climbed close to the 5% threshold, approaching the peak levels seen in 2023 when the Fed pushed interest rates to their highest in over two decades.
Pricing in the futures market also reflects this pessimistic outlook. As of last Friday, traders had essentially ruled out the possibility of Fed rate cuts in 2026 and priced in about a one-in-three chance of a 25-basis-point rate hike within the year.
However, Kelsey Berro, a fixed income portfolio manager at JPMorgan Asset Management, pointed out that the market's focus is misplaced. "Every day the conflict persists, the market moves closer to being forced to confront the negative growth implications, which should ultimately push Treasury yields lower," she stated, adding, "Yields have broadly risen to attractive levels."
**Pimco: Inflation Shock Evolving into Growth Shock**
Daniel Ivascyn, Chief Investment Officer at Pimco, offered a more direct assessment. The asset management giant, which oversees over $2 trillion, currently estimates the probability of a U.S. recession within the next 12 months at more than one-third.
"Inflation shocks often quickly morph into growth shocks," Ivascyn said. "We are at an inflection point for significantly weaker economic conditions."
Goldman Sachs has also raised its probability of an economic recession in the next 12 months to around 30%.
From the perspective of Pimco and JPMorgan, such pessimistic expectations are typically positive for bonds because they increase the likelihood of the Fed cutting rates to stimulate the economy. The unique challenge now is that surging energy prices have put the Fed in a dilemma. With inflation already stubbornly above target, the central bank's room to cut rates is severely constrained. This is the fundamental reason behind the unusually fierce bond sell-off.
Furthermore, even before the conflict erupted, the U.S. economy was showing clear signs of fatigue. The job market continues to cool, with employers cutting 92,000 jobs in February. March's non-farm payroll data is expected to show only a modest rebound to 60,000 new jobs. Concurrently, uncertainty in the artificial intelligence sector and localized stress in the private credit market are also weighing on sentiment. The outbreak of conflict has further exacerbated this fragility.
**Some Institutions Begin Positioning, Awaiting Clarity**
Although the outlook remains uncertain, some institutional investors have already started to act.
Ed Al-Hussainy, a portfolio manager at Columbia Threadneedle, said that as 30-year yields continue to rise, he has begun increasing holdings of long-term bonds. His reasoning is that if the Fed ultimately chooses to hike rates, the resulting suppression of overall economic demand would actually push long-end yields lower. "The more the Fed leans towards tightening policy, the more the long end of the curve needs to price in the damage to aggregate demand and inflation premiums," he explained.
Rick Rieder, BlackRock's Chief Investment Officer of Fixed Income, also stated that he believes the Fed should still cut rates to cushion the economic impact. He is prepared to increase purchases of short-term bonds as the outlook becomes clearer. "Let's see what happens in the coming weeks—then I'd like to step in and buy," he said in an interview.
The anomalous decline in U.S. Treasury yields last Friday may be an early sign that this logic is starting to gain traction in the market. For the first time, amidst the dynamic of "high oil prices and low stock markets," U.S. bonds moved independently, decoupling from the prevailing inflation narrative.
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