What’s Driving the Market Selloff? A Deep Dive into Bonds, Yields, and the Fed

Markets have had a rough ride lately. Just last Wednesday, we hit fresh all-time highs, only to see a sharp selloff in the days since. As of writing this, the S&P 500 has dropped around 4.5% in just five trading days. So, what’s going on? What’s driving this pullback?

If you follow financial media, you’ll hear a common explanation: the bond market. Specifically, falling bond yields have been blamed for the market's weakness. But does that explanation really hold up? Let’s break it down and take a closer look at the broader macroeconomic forces at play.

The Bond Market’s Message—Should We Be Concerned?

A traditional macroeconomic interpretation of falling bond yields suggests that investors are flocking to safety due to concerns about future economic growth. If the market truly feared a slowdown, we’d expect capital to shift into bonds, pushing prices up and yields down. This logic, at least in theory, makes sense.

But here’s why I don’t buy that explanation this time around: nothing in the data suggests a meaningful slowdown ahead. In fact, all signs point to continued growth through 2025, albeit driven by a different dynamic than we saw in 2023 and 2024. Instead of deficit-driven growth, we appear to be entering a new credit cycle that will fuel expansion moving forward.

Yet, despite strong macro fundamentals, we’re seeing extreme bearish sentiment. The AAII sentiment indicator recently hit levels not seen since the worst of the 2022 selloff. But is this fear justified? I’d argue no. Instead, I see a more technical explanation for the recent bond market moves—and by extension, the equity market’s reaction.

The Debt Ceiling & Supply Shock in Treasuries

One of the biggest factors currently at play is the recent debt ceiling hit, which occurred around mid-January. When the government reaches the debt ceiling, it can no longer issue new bonds to finance spending. However, government spending doesn’t just stop—it continues, funded from the Treasury General Account (TGA) at the Federal Reserve. This means fresh reserves are entering the private sector, increasing demand for safe assets like Treasuries.

Under normal conditions, the Treasury offsets spending by issuing bonds and notes across the duration spectrum. But with the debt ceiling in place, that supply has been cut off, creating a temporary shortage of Treasuries. With demand strong and supply constrained, it’s no surprise that bond prices are rallying and yields are falling.

What’s critical to understand is that this dynamic is entirely mechanical—it has nothing to do with deteriorating economic fundamentals. If your trading model simply says, “falling yields = bad for stocks,” you’d be selling equities right now for the wrong reasons. And historically, when we’ve seen debt ceiling-related disruptions like this, bonds have rallied, yields have fallen, and equity markets have wobbled—only to stabilize once the issue is resolved.

Fed Policy, QT, and Treasury Issuance—What It Means for Markets

On top of the debt ceiling dynamics, we also have significant policy developments from the Federal Reserve and the Treasury. The Fed recently signaled that it will pause Quantitative Tightening (QT), which means it will stop allowing its bond holdings to roll off its balance sheet. The Treasury, for its part, has indicated that when new bond issuance resumes, it will favor longer-duration securities.

Why does this matter? Some argue that changes in the composition of financial assets—whether driven by the Fed’s balance sheet adjustments or the Treasury’s issuance strategy—can meaningfully impact market valuations. But from a macro perspective, this view is flawed. The structure of financial assets in the private sector doesn’t dictate future economic growth; rather, it’s profit expectations that drive investment, credit creation, and ultimately, economic expansion.

This is where conventional economic thinking often goes astray. Many analysts assume that investment and lending depend on existing pools of financial assets—what’s known as the “loanable funds” theory. But in reality, money is created endogenously. Loans create deposits, not the other way around. The key factor determining credit expansion isn’t the supply of financial assets but rather the expectation of future profits. If businesses see profitable opportunities, they will borrow and invest, regardless of the specific mix of assets in circulation.

Winners and Losers in the Market Reset

While changes in Fed policy and Treasury issuance may cause temporary dislocations, they don’t alter the trajectory of economic growth in the long run. What they do is shift the relative winners and losers in financial markets. Initially, we’ve seen some of the biggest names in the stock market take a hit as investors adjust to these shifts. But over time, as new winners emerge, markets will stabilize and resume their broader upward trajectory.

History tells us that when these policy-driven market dislocations occur, the dust eventually settles, and markets reorient around the real driver of asset prices: economic growth. As we move deeper into 2025, as long as macro fundamentals remain intact, we should expect markets to reflect that reality.

Looking Ahead—What to Watch For

For investors, the key takeaway is this: don’t get caught up in surface-level narratives about bond yields signaling an imminent downturn. The real story is about fiscal flows, policy-driven distortions, and the underlying strength of the economy. As long as government spending continues and the private sector remains healthy, the conditions for growth remain intact.

Barring any major surprises from Washington, I expect we’ll see a significant credit expansion later this year, further fueling economic growth and, ultimately, higher equity markets. The recent volatility is just noise—what matters is the big picture.

If you want a deeper dive into this topic, watch my latest video here: