By Joy Wiltermuth and Joseph Adinolfi
The stock market keeps touching fresh record highs, while the bond market is girding for trouble in the economy
The bond market usually sniffs out trouble in the economy, but there’s also a lot of momentum in the stock market to keep the rally going.
U.S. stocks roared to fresh record highs on Thursday, fueled by optimism around Federal Reserve interest-rate cuts that could arrive just in time to keep the party going on Wall Street.
Yet as stocks jolt higher, the bond market’s message has been more grim – with many investors now bracing for the possibility that the U.S. economy isn’t as resilient as previously thought.
That’s backed up by a trend in September where investors have come flooding back into longer-duration bonds that were shunned earlier this year. The defensive moves follow months of weaker U.S. jobs data and a growing sense of unease about the Fed potentially needing to come to the economy’s rescue.
“There are things that worry me here,” said Bob Savage, head of markets macro strategy at BNY – pointing to equity markets that appear to view any Fed rate cuts as likely to accelerate corporate profits, whereas the bond market sees a faster pace of rate cuts possible due to economic trouble. “Who is going to be wrong?” Savage asked.
Yields on the benchmark 10-year Treasury note BX:TMUBMUSD10Y briefly slipped below 4% Thursday – a level last seen intraday in early April, when President Trump’s “liberation day” tariff announcement sent investors into a recession panic and into the arms of safe-haven assets. Bond yields fall as prices rise, and vice versa. As yields have fallen, the iShares 20+ Year Treasury Bond ETF TLT, which holds long-dated Treasurys, has seen its price appreciate. The yield on the note stood at 4.01% as of 3 p.m. Eastern time in New York, the lowest end-of-day level since April 4, Dow Jones Market Data showed.
Savage said anything below 3.5% for the 10-year Treasury yield would certainly raise eyebrows regarding the economy’s health. “One thing people want to hear from the Fed at this meeting [next week] is some confidence that the economy is not going into a recession,” he said.
While a recession doesn’t look likely now, Savage noted, investors will have to wait for more clarity from third-quarter earnings starting in October on how companies are handling higher tariffs.
Trump’s tariffs have been prone to on-again, off-again announcements since April as trade negotiations play out, making difficult the job of gauging their impact on the economy. But by early August, the Yale Budget Lab estimated that U.S. consumers faced an effective tariff rate of 17.7%, the highest level since 1934.
Treasury Secretary Scott Bessent recently dismissed the costs of tariffs, while saying recent court decisions deeming them illegal could be “terrible” for the Treasury if the Supreme Court were to rule against the Trump administration and require tariff refunds.
Meanwhile, Thursday’s consumer-price index for August showed that “tariff pass-through to goods prices is continuing gradually, and services inflation was firmer than the Fed would have preferred, albeit for noisy reasons,” according to Tiffany Wilding, a Pimco economist.
Wilding said that the weekly jobless-claims data released Thursday was “arguably the bigger news,” given that it reinforced concerns about the U.S. labor market.
See: First-time unemployment claims surge to highest level since 2021 – but most of the increase is tied to Texas flooding
Yet the S&P 500 SPX, Dow Jones Industrial Average DJIA and Nasdaq Composite COMP stock indexes all logged record closing highs on Thursday.
“Investors are in the greed phrase,” said Emily Bowersock Hill, chief executive and founding partner of Bowersock Capital Partners – adding that her team is expecting a mild correction in stocks, given that September tends to be tough for equities. “But now we are halfway through September,” she noted, and momentum remains so strong that a pullback this month looks “very unlikely to happen.”
The fresh upswing for stocks followed the August CPI inflation report, which showed inflation climbing again but likely not by enough to stop the Fed from cutting rates next week.
Since January, the U.S. central bank has kept its short-term policy rate steady in a 4.25% to 4.5% range, hitting pause after it lowered rates by 1% in 2024 from peak pandemic levels.
Are stocks getting it right?
While the outlook for the U.S. economy isn’t perfect, things are still looking pretty good for equity investors, said Mark Gibbens, chief investment officer at Gibbens Capital Management. The labor market is slowing, and the housing market and manufacturing activity are struggling as well. But capital investment driven by the artificial-intelligence boom has surged, and consumers have continued to increase their spending.
Investors have weathered a lot of curveballs already this year, from Trump’s April tariff shock to his threats to fire Fed Chair Jerome Powell. Geopolitical tensions including Israeli and U.S. strikes on Iran also failed to shake up stocks. Instead, valuations remain near the high end of their historical range, and major indexes like the S&P 500 are still trading at records.
“Stocks might be sending one message about the economy and bonds are sending another,” Gibbens told MarketWatch in an interview. “But this bull market is innocent until proven guilty, and equity investors are winning that argument right now.”
It is also worth pointing out that stocks and bonds aren’t always on the same page. U.S. stocks and Teasurys briefly sent mixed messages about the economy last year, when the Fed was preparing what ended up being its first interest-rate cut since the COVID-19 pandemic.
The outlook, at least for the near term, looks solid – with one key caveat. The slowing labor market could be a potential concern.
“It’s looking pretty good right now, but if we get a drastic change in consumer behavior driven by the labor market, that could obviously be a bigger story,” Gibbens said. Investors, and the Fed, will likely be keeping a close eye on the jobs data going forward.
Historically, when the Fed has cut interest rates outside of a recession, stock-market performance over the following 12 months has been strong, according to data shared by Deutsche Bank’s Jim Reid.
At the same time, the track record for how bonds have performed in such an environment has been more mixed. DataTrek’s Nicholas Colas pointed out that as the Fed continues to cut rates, shifts in 10-year Treasury yields usually show a marginal decline in yields on average – but the overall average direction is hardly definite. After borrowing costs are lowered, long-dated bond yields sometimes rise.
Investors got a taste of this last year. After the first Fed rate cut, the yield on the 10-year Treasury note actually rose, FactSet data showed. There is a relatively straightforward explanation for this, Colas said.
“When the Fed is fine-tuning policy rates rather than responding to recession, the market can read that as either a sign that inflation is under control or that lower rates might spark an increase in aggregate demand that pushes prices higher,” Colas said in commentary shared with MarketWatch last month.
As for the labor market, the monthly jobs report for August showed the economy added only 22,000 new jobs, while recent data revisions have painted an even darker picture of the labor market since last year.
Whatever happens, one thing is clear: Economic data is a big deal for markets once again. If the labor market slows any further or if inflation accelerates, those developments will become increasingly difficult to ignore, Gibbens said.
Among investors, the hope is that the Fed will cut interest rates quickly enough to stave off any further weakness in the economy, Gibbens added. At the same time, investors are hoping that additional price pressures caused by the tariffs will be modest.
-Joy Wiltermuth -Joseph Adinolfi
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09-11-25 1620ET
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