Why Bond Yields Are the Stock Market’s New Fear Index

The myriad issues facing the economy aren’t being reflected in traditional risk gauges. But you can’t fool the bond market.

(Illustration by Matt Chase)

Key Points

• Treasury yields are acting as Wall Street’s new fear gauge, supplanting traditional risk measures like the muted Cboe Volatility Index.
• The 10-year Treasury yield rose about half a percentage point over the past six months, and the 30-year yield hit a 19-year high in mid-August.
• U.S. Treasury Secretary Scott Bessent unveiled plans to more than double the size of long bond buybacks to help bring yields down.

Treasury yields are acting as Wall Street’s new “fear gauge,” supplanting traditional risk measures as investors parse the impact of a host of fiscal, monetary, and geopolitical issues that are piling up into the final months of the year.

This change of focus for rates—from mostly expressing views on growth and inflation to warning about issues including fiscal largess, artificial-intelligence investments, global oil prices, and election risks—represents a key change for investors.

It also comes at a crucial time for stocks, which are hovering near all-time highs. They’ve booked only modest gains over the past three months, and are looking to break out of a trading range that has been in place since early spring.

“The bond market is sending a rational message,” says Neil Shearing, group chief economist at Capital Economics. “The world is riskier, government debt burdens are higher, inflation risks are less predictable, and the political willingness to address fiscal problems is limited.”

The 10-year yield has increased by about half a percentage point in the past six months, and the 30-year yield hit a 19-year high in mid-August.

“Some of the recent rise in yields may unwind,” Shearing says. “But the old world is gone, and these underlying forces mean upward pressure on term premia is likely to be a lasting feature of the postpandemic age.”

That’s particularly true now that the myriad issues facing the economy, and broader investor sentiment, aren’t being reflected in traditional risk gauges.

The Cboe Volatility Index , or VIX, the market’s go-to reading for a day-to-day assessment of broader market risks, has been oddly muted over the past year.

The VIX uses options prices to compute the volatility expected over the next 30 days; because higher levels can indicate that traders are paying more to protect themselves against market drops, it is known as Wall Street’s “fear gauge.” But recently, it has signaled anything but. The VIX has hovered around 15 for the past month, hitting the lowest levels of the year in early August, and has closed north of the 20-point mark—a level typically associated with elevated, but not extreme, volatility—on only three trading days in the past four months.

This belies the myriad risks encircling markets as we enter what is traditionally the most difficult stretch of the year.

First and foremost is the trajectory of U.S. debt, which topped the $40 trillion mark for the first time in August, with $50 trillion in sight by the end of the decade.

Near-term borrowing issues aren’t much better, with this year’s deficit on track to top the $2 trillion mark and next year’s tally expected to rise to $2.1 trillion.

Underneath that, we have a stingier consumer. Retail sales fell the most in more than a year in Jul y, a move triggered in part by a fading boost from the tax refunds that helped consumers in the spring.

The job market is also in a rut, with more than 23,000 jobs lost in July, according to data from the Bureau of Labor Statistics, and revisions to the previous two months lopping 103,000 hires from this year’s overall tally.

The weaker economic readings aren’t likely to worry equity investors just yet: The principal market drivers remain focused on the AI investment trade and semiconductor and energy stocks, none of which are massively affected by a weakening consumer or a slowing job market.

Bonds, on the other hand, still need to reflect the changes in interest-rate risks tied to the Federal Reserve and its reaction to a slowing economy.

Seema Shah, chief global strategist at Principal Asset Management, says rising bond yields in the wake of softening jobs and retail and housing data suggest investors are moving from an inflation story, controlled in part by the Fed, to a “term-premium story,” implying risks that are beyond the central bank’s control.

“This distinction is important,” she says, and the implications for stocks are acute.

“Higher bond yields reduce the present value of future earnings and place downward pressure on valuations, particularly in long-duration growth sectors,” Shah says. “They may also threaten one of the market’s key supports: the wave of AI-related capital expenditure.”

The biggest hyperscalers have raised more than $300 billion from the bond market this year, according to Bank of America Global Research, more than double last year’s $136 billion tally.

Risks in financial markets are also on the rise, with pointed questions over the pace of AI investment spending, and the lack of a clear read on its bottom-line impact, contributing to a pullback in the market’s biggest stocks. An index of the so-called Magnificent Seven tech giants has fallen some 5% since peaking in late May, while the PHLX Semiconductor index has slumped nearly 22% from the record levels it reached in late June.

The S&P 500 , meanwhile, remains ensconced in its recent trading range, and is less than 2% away from the record close of 7799 on Aug. 13.

Wall Street forecasts suggest only modest gains between now and the end of the year, with a median price target of 8000, per Bloomberg data.

Geopolitical concerns, of course, are constant. The U.S. war with Iran, now moving swiftly past its six-month anniversary with little hope of a peace deal in sight, continues to push global crude prices higher, stoking inflation concerns.

Brent crude futures, in fact, traded north of $92 a barrel earlier this month, and have risen nearly 20% since the start of July. Futures markets don’t see it retreating to prewar levels until the spring of 2029.

With the VIX silent to these risks, the bond market is picking up the slack.

Recent increases in longer-term Treasury yields have compelled a stark reaction from the Trump administration, which is keen to stop broader market disruption from capturing headlines during the midterm election cycle, and to bring yields down to make America’s debt load more manageable.

U.S. Treasury Secretary Scott Bessent unveiled plans to more than double the size of long-bond buybacks, a surprising move that drew a sharp negative reaction from, among others, hedge fund titan Stanley Druckenmiller. “Governments defending prices against fundamentals always lose,” he wrote in a Wall Street Journal op-ed.

These actions have the potential to lift the bond market’s key volatility reading: The ICE BofA MOVE Index heading into the autumn. The MOVE index has been rising steadily, if quietly, since early June, since the yield increases have been orderly. Historically, stocks have managed rising yields decently, as long as bond volatility remains restrained.

There’s still plenty to like about stocks, even as the market loses some of its early-August steam. Third-quarter earnings are expected to grow by around 30%, according to LSEG forecasts.

The U.S. economy is likely to grow by around 2%, fast enough to avoid any major labor market issues, but not so quick as to stoke significant inflation concerns.

Still, the risks to those outlooks, and the signals investors need to follow to avoid them, are likely to be found in the bond market. And that is likely to keep it at the front of investors’ minds in the final third of the year.

Write to Martin Baccardax at martin.baccardax@barrons.com

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