Bond markets signal caution – time to pay attention
In this week’s video insight, I explore the complex interplay between Trump’s political theatrics and the U.S. bond market. I discuss how the Trump administration’s liquidity-flooding tactics (via short-dated Treasury bills and Federal Reserve mechanisms) have supported markets but also risk fuelling future volatility. With 10-year Treasury yields hovering near a critical 4.5 per cent threshold, concerns are rising over the sustainability of the U.S.’s growing debt load, pressure from bond vigilantes, and signs of increasing term premia. Compounding these risks are a record federal deficit, political tensions over the debt ceiling, and Moody’s recent U.S. credit downgrade. While liquidity has masked deeper vulnerabilities, the bond market may soon reassert itself as a key source of instability for portfolios.
Transcript:
Hi I’m Roger Montgomery and welcome back to this week’s video insight.
Let’s start by summarising Trump’s approach to deal making, his presidency, and the commercialisation of the White House.
I heard someone say, ‘what Trump does is create a problem and then solves the problem he created by undoing the thing he did, claiming credit for the end result, which is, of course, nothing’.
With that out of the way, and by the way, there’s a decent hint in there about how to take advantage of Trump’s apparent chaotic approach to foreign relations – let’s take a look at the U.S. Bond Market. While it’s not making waves right now, it could be the next source of volatility and portfolio reweighting.
U.S. treasury bonds are the backbone of global finance – safe, reliable, and a key indicator of market health. Right now, the yield on US10-year treasuries is sitting around 4.5 per cent, which is significant because it’s a threshold the Trump administration seems keen to keep a lid on…
The catch? There are forces at play wanting yields to climb higher, and that’s why things could get interesting just as everyone catches their breath from all the tariff and trade war disturbances.
The U.S. government has been injecting massive liquidity – around US$6 trillion since early 2024 – into the financial system. How? Through a strategy that leans heavily on short-dated Treasury bills, which are like quick, one-year loans, instead of longer-term bonds. This approach, combined with the Federal Reserve drawing down its Reverse Repurchase Facility, has flooded markets with cash. It’s Claytons Quantitative Easing.
Think of liquidity as the lubricant that keeps the financial wheels turning – it supports stock prices, lending, and more. It’s been a form of “Treasury-led QE,” effectively monetising the federal deficit. The Federal Reserve’s contributed about US$2 trillion, while the Treasury’s shift to bills has added another US$4 trillion by reducing the “dollar duration” of its debt.
This liquidity surge is a boon for markets – 80 per cent of global lending now relies on collateral like Treasury bills, which banks love because they’re less demanding on balance sheets. But here’s where it gets dicey. This strategy could be stoking longer-term risks. Bond yields are under pressure because some investors – those called “bond vigilantes,” will inevitably demand higher returns to hold long-term debt. Why? They’re worried about the U.S.’s growing debt pile and the sustainability of this bill-heavy approach. Indeed, the term premia – the extra yield for holding long-dated bonds – is creeping up, signalling rising duration risk. And if 10-year yields break past 4.5 per cent, we could see volatility spike, which would crimp the collateral multiplier that drives liquidity. Liquidity would decline and with it, support for stocks.
Now, let’s layer in some external factors that are adding fuel to this fire. First, Trump. Despite President Donald Trump’s claims of reducing the federal deficit, data shows the deficit has been increasing. For fiscal year 2025, the U.S. budget deficit for the first five months (October 2024–February 2025) reached a record US$1.147 trillion, with February alone showing a US$307 billion deficit, up 4 per cent from the previous year. This increase occurred despite efforts by the Trump administration’s Department of Government Efficiency (DOGE) to cut spending. Second, the U.S. debt ceiling. This is the legal limit on government borrowing, and it’s a political hot potato. If Congress stalls on raising it, markets could get jittery again, pushing yields higher. Third, Moody’s recently downgraded the U.S. credit rating to AA1. It’s not a catastrophic change to the U.S. credit score, but it flags concerns about rising debt levels. And finally, the Treasury plans to buy back US$50 billion in bonds by early August to manage debt maturities. This could tighten the supply of long-dated bonds, further pressuring yields upward.
So, what’s the takeaway? Well, the bond market is a bit of a crystal ball for the economy, liquidity and the appetite for risk. Rising yields could make borrowing costlier, slow growth, and dent stock prices. And while The Federal Reserve’s sitting on the sidelines for now, a yield surge or inflation spike could force their hand. Either way, the bond market’s signaling caution, and it’s time to pay attention.
That’s all we have time for today. Continue to follow us on Facebook and X.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
