The bond market is weird right now

Something unusual has happened in the last few days.

Trump's tariffs have whipsawed global financial markets. As of this writing, the Dow Jones Industrial Average (a measure of large US-based company stock prices) has fallen by more than 6,000 points – a total of 14.5% – since his first day in office.

Normally, when stock markets fall, bond prices go up. That's because investors choose where to put their money. If they expect further declines in the stock market, they'll sell stocks and buy bonds.

I wrote about Treasury bonds a couple of days ago. These are very popular among investors around the world, because the US government's "full faith and credit" policy assures investors that their money is safe.

When the US Treasury offers a bond for sale, it sets a term and an interest rate for it. In 2024, you could buy a two-year Treasury bond that paid 5% interest per year. If you paid $10,000 for a Treasury, you'd get $500 in interest each year, so $1,000 over the two years you held it. Those payments would come to you monthly – $1,000 divided by 24 is a check for $41.67 every month. At the end of the two years, you'd get your original $10,000 back, for a total of $11,000.

You don't have to buy Treasury bills from the US government, though. Lots of people buy them, and some of those people decide they need their money sooner than the end of the term, when they would get paid back in full. There's a brisk trade in Treasuries that have paid out some of their monthly dividends but still have some time to run.

If you offered to sell me your Treasury after collecting one year of dividends, I'd know I was going to get the original $10,000 back (because I'd be the owner at the end of the term), and that I'd be getting a total of $500 in payments over the course of the remaining year. So the dollar value of the Treasury to me would be $10,500.

Of course I'm not going to pay you that. For one thing, I want a return on my investment – you were getting $41.67 a month, or $500 for the remaining year of the term. That's my interest if I own the bond, not yours. I'm not even likely to pay you the face value of the bond – the $10,000 you paid, that I'll receive at the end of the term. I know you need to sell or you wouldn't be talking to me. Your desperation is my profit opportunity. And I can shop around, find the most desperate seller I can locate, and buy from him. So the price I'll pay you is effectively capped at what the most desperate seller in the market is willing to accept.

Let's say there are lots of desperate sellers, so I can buy your $10,000 face-value bond for $8,000. I'm still going to get $500 in monthly payments from the US Treasury – that's written into the bond – so my effective annual interest rate is 500/8000, or six and a half percent.

That 6.25% is my yield – the effective interest rate I get from buying a bond on the spot market today. In this example, it's higher than the original bond rate. It's a really important number.

Investors can choose to buy Treasuries on the spot market or directly from the US Treasury. The Treasury can't sell any bonds if it is offering a lower interest rate than the yield that buyers could get in the spot market. So – to keep it simple, and almost entirely correct – the yield I get from the spot market effectively sets the interest rate that the US Treasury has to pay on its new bonds.

When yields go up, it gets more expensive for the US government to borrow money.

I said above that stock prices and bond prices generally move in different directions. If stock markets fall, investors usually sell equities and buy bonds. There are more buyers than sellers in the spot market, which drives bond prices up (lots of us competing to buy your bond), sending yields down.

That's not happening right now. Stock markets are falling precipitously, and bond prices are doing the same. Yields are surging, driving up borrowing costs for the Federal government. Treasury yields are a key driver of consumer interest rates as well – car loan and mortgage interest rates are set to climb as well.

The Wall Street Journal reports that the market is in a new mode: "sell everything American." Stocks and bonds are no longer functioning in the way they used to – both are falling simultaneously, as the world sheds its investments in the US.

Since Treasuries are the way that the US government borrows to fund the budget shortfall, further declines in the Treasuries market and corresponding yield increases will make our current debt (we continually refinance it by selling new Treasuries and paying off the old ones) and our continuing deficit much more expensive, and much more painful.

Critically, China holds a substantial fraction of all outstanding US Treasuries – as of January 2025, $760.8Bn worth, or nearly nine percent of the total. Should our geopolitical adversary decide to liquidate those holdings, the effect on US interest rates and the broader market would be absolutely brutal. Selling would, of course, be painful for China as well, as it would sell them below their face value. At some point, though, that pain may become tolerable in a trade war.

And the Trump trade war has turned many of our former allies and trading partners into trade war enemies as well. China is not alone in its power to harm US markets.