A sharp spike in yields across the United States Treasury market has drawn heightened scrutiny from investors, as long-term rates surged by nearly 50 basis points in recent days, adding to global market turbulence.
However, according to Stephen Dover, chief market strategist and head of Franklin Templeton Institute, the recent volatility reflects technical dislocations rather than any deterioration in macroeconomic fundamentals.
“This spike in yields appears to be more technical than fundamental,” Dover said. “We begin with the facts. Long-term Treasury yields are rising sharply and much faster than short-term yields, leading to a steepening of the yield curve. Why is that happening? In theory, various factors could be behind the jump in bond yields. It might be that investors are worried about inflation, insofar as tariffs will boost US inflation. It could be that investors are worried about large US budget deficits and debt levels. Or it could be that investors are concerned that countries hit by tariffs, such as China or Japan, might stop buying Treasuries or even might sell their massive stockpiles of them.”
Look at liquidity
Dover argues that prevailing indicators do not support these concerns. “None of those reasons is, for now, compelling,” he said, pointing to a muted 10-year breakeven inflation rate of 2.22% and relatively stable deficit projections. He added that a major withdrawal of foreign demand for US Treasuries would likely exert more pronounced pressure on the US dollar.
Instead, Dover believes the turbulence is likely being driven by leveraged positions. “The probabilities therefore suggest that leveraged positions in Treasuries (including basis trades or positions in swap markets) are the source of this week’s selling pressures. Of itself, that could be benign—or possibly not.”
While the Federal Reserve may intervene if systemic risk emerges, Dover expects any response would focus on liquidity, not rate adjustments. “The Fed’s engagement would probably not be via interest rate cuts, but rather via commitments to provide targeted liquidity,” he said.
He also cautioned that persistently high long-term yields could pose risks to economic growth and corporate earnings. “In that regard, we think they represent a further risk to the outlook for US and global growth and corporate profits.”
Dover concluded: “We’re closely monitoring the situation. But at this point, the evidence points to technical pressure and not a broader shift in economic outlook.”