The safe-haven appeal of U.S. Treasuries shows initial signs of returning; amid cracks in the AI trade, bond market bears face a test of short covering.

Last week, U.S. Treasuries showed initial signs of a return to their safe-haven attributes. Investors who had previously made large bets that the bond market would continue to decline this year may therefore face a test of covering their positions. As market concerns intensified over the outlook for leading artificial intelligence (AI) companies and their potential impact on the broader economy, the 10-year U.S. Treasury yield fell by about 17 basis points last week, while the Nasdaq 100 index plunged 5.5% over the same period. The last time the 10-year U.S. Treasury yield and the Nasdaq 100 index fell so sharply in the same week was during the tariff turmoil in April 2025. This bond market rally is noteworthy because, for several months prior, U.S. Treasuries had failed to provide effective safe-haven protection as they normally do when stocks came under pressure. Elevated inflation, a still-resilient economy, and heavy government and corporate issuanceincluding financing for the AI boomcombined to push the 10-year U.S. Treasury yield to its highest level in more than two decades over the past seven months. The latest round of stock market volatility broke that trend. Part of the reason is that investors had previously held unusually aggressive bearish bets on U.S. Treasuries, which increased the possibility of short covering, i.e., bears buying back bonds to close positions and thereby pushing prices higher; even with inflation still stubborn, the risk of two-way volatility in the bond market is rising. James Athey, portfolio manager at Marlborough Investment Management, said: "To paraphrase Mark Twain, reports of the 'death' of U.S. Treasuries have been greatly exaggerated." Safe-haven funds return to U.S. Treasuries as tech stocks slump Of course, it is too early to assert that the AI boom is about to end. Previous rounds of market volatility also proved relatively short-lived. But signs of slowing revenue growth at Anthropic PBC and falling bond prices at AI cloud computing service provider CoreWeave Inc. have led the market to begin questioning whether the AI trade that had helped drive the bond selloff is now showing cracks. Large-scale AI investment has boosted the economy, while surging demand for computer chips has intensified inflationary pressure. Cracks appear in the AI trade, and the safe-haven value of U.S. Treasuries draws attention again Afonso Borges, fixed income strategist at Julius Baer, wrote in a report that "an AI-induced recession would be closer to a traditional negative demand shock" and could become a catalyst for deflation. He said that in such a scenario, "intermediate-term U.S. Treasuries should once again play an effective portfolio hedging role." Against this backdrop, the institution recommends increasing exposure to longer-duration bonds in the intermediate term. Borges noted that during stock market drawdowns from 2000 to 2020, 10-year U.S. Treasuries consistently delivered positive returns. Heavy issuance by companies financing AI infrastructure has intensified competition for capital and become another headwind for U.S. Treasuries. If AI investment expectations fade, the impact of these factors may reverse. Investment-grade companies led by mega-cap tech companies have issued about $1.7 trillion of bonds this year, up about 29% from the same period last year. John Briggs, head of U.S. rates strategy at Natixis North America, said: "If investors see AI-related bonds depreciating, their willingness to buy new debt will decline. Therefore, in the short term, the issuance channel for AI bonds has narrowed somewhat, and as a result investors are buying more long-term U.S. Treasuries because concerns about crowding out have diminished." If the AI trade continues to weaken, trader position adjustments could also amplify the bond market rally. The rise in U.S. Treasuries was helped by commodity trading advisors (CTAs, trend-following funds) exiting bearish futures positions; these investors were extremely bearish when they built positions last week. Safe-haven buying pushes U.S. Treasuries higher, but inflation and oil prices remain variables Safe-haven inflows helped ease the pressure on bonds from persistent inflation. Last week's higher-than-expected consumer price data initially prompted traders to increase bets on a Federal Reserve rate hike this month, with the probability briefly rising to about 50%. But as the stock market selloff intensified, the market-implied probability of an October rate hike declined. Federal Reserve Chair Kevin Warsh spoke at the International Monetary Fund annual meeting and, apart from reiterating that the Fed will maintain price stability, made no comments on monetary policy or the economic outlook, further reducing the likelihood of a rate hike. Traders still expect the Fed to raise rates once by the end of the year and again in 2027. Given these expectations, Steven Barrow, head of G10 strategy at Standard Bank, called the recent bond rally a "smokescreen." He noted that future inflation risks remain and that market structure is shifting toward favoring equities and moving away from sovereign bonds. The surge in oil prices last Friday also showed that the role of bonds as a hedging tool can easily be upended. Oil prices had already risen sharply during the Iran war and exacerbated inflation concerns. As the market questioned U.S. President Donald Trump's agreement to release more Russian diesel into global markets, crude oil prices rose, and U.S. Treasuries and stocks weakened in tandem around midday that day. Looking ahead, Masahiko Loo, senior fixed income strategist at State Street Investment Management in Tokyo, said the uncertainty created by Warsh's lack of forward guidancea core principle of his monetary policy approachmakes the market more prone to large price swings. However, Loo said that for long-term investors, "the situation is different." "If a larger AI-driven safe-haven move occurs, U.S. Treasuries appear increasingly capable of providing the hedge that investors have lacked for most of the past few years."