By Paul R. La Monica

It wasn't long ago that a big worry was sticky inflation pushing the 10-year Treasury yield above 5%. So much for that.

Now, a big worry is low bond yields. The 10-year is now on the precipice of a 3-handle, dragged down by the new tariffs imposed by President Donald Trump. The trade moves triggered a stock market selloff that sent investors fleeing to the safety of bonds. Yields, which move in the opposite direction of prices, sank.

To show just how fast Wall Stree is moving, the 10-year yield nosedived to about 4.05% late Thursday morning from around 4.2% in roughly 18 hours.

"Quality bonds offer a diversification benefit in an uncertain equity market environment," said Jack Ablin, chief investment officer of Cresset, a wealth management firm, in a report.

Still, economic uncertainty and tariffs aside, investors need to be careful even with supposedly safer bonds. For one, corporate bonds, especially high-yield, probably will suffer if the stock market rout rolls on and companies start warning about earnings.

Both the iShares iBoxx $ High Yield Corporate Bond exchange-traded fund and SPDR Bloomberg High Yield Bond ETF , for example, were each down more than 1% on Thursday. The benchmark iShares Core U.S. Aggregate Bond ETF rose nearly 1%.

Spreads between so-called junk bonds and Treasuries are widening, now at about 3.4%. But that spread, the difference in yields, has tended to be much higher in times of market and economic stress.

It was above 5% when stocks plummeted in 2022 because of high inflation. Bonds plunged that year, too, a rare instance when both equities and fixed income soured simultaneously.

The spread surged above 10% at the beginning of the Covid pandemic in March 2020. And it skyrocketed to nearly 20% during the worst of the 2007-08 financial crisis.

So the yield on junk bonds and Treasury rates could cleave even more if this market volatility keeps going. A higher spread just might be inevitable.

"Corporate bonds were already expensive relative to Treasuries," said Tom Graff, chief investment officer with Facet, a financial planning firm. "If we are heading into a recession, spreads need to widen a bit more and corporate bonds would underperform."

Graff makes the case for municipal bonds. Instead of chasing risker higher yields -- or rushing into Treasuries that have already rallied -- consider munis, which have lagged behind longer-term Treasuries but still offer relatively high (and tax-exempt) yields.

"Treasuries are the ultimate safe haven," he said. "Munis may take time to catch up but you can get a pretty nice tax-free yield while you wait."

To Graff's point, the iShares National Muni Bond ETF and Vanguard Tax-Exempt Bond ETF, which are both down about 1% this year, have average yields above 3%.

Investors shouldn't ignore Treasuries, though. The flight to quality toward sovereign bonds globally will continue, Brendan Murphy, head of fixed income for North America at Insight Investment, told Barron's in an email.

"Our portfolios have generally been positioned to be long duration in short to intermediate parts of the high quality sovereign markets," he said, adding that investors should also consider "moderate overweights" in U.S. Agency mortgage-backed securities as well as investment-grade corporate bonds.

Murphy added that a global trade war may eventually push the Federal Reserve to cut interest rates again sooner rather than later, which could push bond yields even lower -- and prices higher.

"With what we know now about the size and scope of tariffs, the near-term implications are clearly negative for growth and to the upside for inflation," he said. "The Fed is likely to look through the short term higher inflation and focus more on the downside growth risks."

The market agrees. Traders, according to fed-funds futures on the CME, are now pricing in a more than 80% chance of a rate cut at the central bank's June meeting, up from 67% on Wednesday.

Write to Paul R. La Monica at paul.lamonica@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

April 03, 2025 11:57 ET (15:57 GMT)

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