Executive Summary

A structural rotation is underway in global capital markets. Capital is flowing out of long-duration U.S. Treasury bonds and into gold, short-duration fixed income, and investment-grade corporate credit. This is not a temporary positioning shift. It reflects a fundamental repricing of what constitutes a safe-haven asset in a world of rising fiscal deficits, declining foreign official demand for Treasuries, growing threats to Federal Reserve independence, and persistent inflation above the Fed’s 2% target.

This note examines the corroborating evidence across bond flows, gold demand, foreign reserve management, and Fed policy dynamics. We assess the implications for equity markets, interest rate trajectories, and portfolio construction in 2026.

Bond Fund Inflows 2025	Gold Price (Feb 2026)	Foreign Treasury Share	10Y Yield Move Since Sep 2024
$540B Record	$5,136/oz (Record)	~30% (from 50%)	+100bps (Despite Cuts)

1. Bond Market Supply and Demand: Record Inflows, Critical Rotation

1.1 Aggregate Flow Data

The bond market is not experiencing broad capital flight. In fact, fund flows hit record levels in 2025 and continued their momentum into January 2026. Taxable bond funds attracted a record $540 billion in 2025, representing 70% of all long-term U.S. fund inflows for the year. In January 2026 alone, fixed-income ETFs pulled in a record $56 billion, with taxable-bond ETFs absorbing $46 billion.

Weekly data from the Investment Company Institute (ICI) through late January 2026 shows bond funds attracting $16.72 billion in a single week, with taxable bond funds accounting for $14.81 billion. At the global level, EPFR-tracked bond funds pulled in approximately $860 billion in 2025, on pace for a second consecutive full-year inflow record.

1.2 The Duration Rotation

While aggregate bond flows are strong, the internal composition reveals a decisive shift. Capital is moving systematically from the long end of the curve to the short and intermediate segments:

• Short-term government bond ETFs: +$4 billion in January 2026
• Intermediate-term government bonds: +$5 billion in January 2026
• Long-term government bond ETFs: Outflows, including -$1.4B from TLT
• Inflation-linked bonds: -$554M outflow ending 12 consecutive months of inflows

State Street research confirms this is not a January 2026 phenomenon. The lack of interest in owning long-term U.S. Treasuries has been a persistent trend throughout 2025, driven by rising deficits, stubborn inflation, monetary easing, and rising term premiums.

1.3 Supply Outlook

The supply side is accelerating. Investment-grade gross bond supply reached a record $1.82 trillion in 2025, with net issuance of $548 billion. For 2026, estimates call for gross issuance of $2.25 trillion and net issuance of $1.0 trillion, which would eclipse the previous gross record of $2.1 trillion set in 2020. Net corporate supply is expected to surge 23%, driven by AI-related capital expenditures and rising M&A activity.

Federal debt outstanding is on track to eclipse the size of the U.S. economy for the first time since World War II in 2026. Combined with expanding tax cuts and upward pressure from Social Security and Medicare, the bond market will need to absorb significantly more government debt, requiring higher yields to attract sufficient demand.

2. Gold: The New Safe Haven

2.1 Price Action and Demand

Gold has surged from approximately $2,600/oz at the start of 2025 to over $5,136/oz in early February 2026, a gain of roughly 97% in just over a year. This represents the most powerful gold rally in modern history, driven by a convergence of structural forces:

• Central bank buying topped 1,000 tonnes for the third consecutive year in 2025
• Total gold demand reached a record 4,974 tonnes ($382 billion) in 2025
• U.S. gold demand more than doubled to 679 tonnes, with ETFs adding 437 tonnes
• 95% of central banks expect gold reserves to grow in the next 12 months

2.2 Central Bank De-Dollarization

The central bank buying trend is structural, not cyclical. Poland, Brazil, and China continue to dominate purchases. Year-to-date through November 2025, reported central bank net purchases stood at 297 tonnes. J.P. Morgan projects approximately 755 tonnes of central bank purchases in 2026, still well above pre-2022 averages of 400-500 tonnes.

Critically, central banks are buying above $4,000/oz because the objective is long-term reserve diversification away from dollar-denominated assets, not short-term trading gains. This creates a structural floor under gold prices that is independent of traditional yield-based valuation models.

2.3 The Broken Gold-Yield Correlation

A notable feature of the 2025 gold market was its record-setting rally during periods of elevated real yields. Historically, gold and real yields shared a strong inverse correlation. The divergence suggests that the opportunity cost of holding a non-yielding asset is being outweighed by geopolitical hedging and sovereign diversification motives. For 2026, this implies that traditional models relying heavily on yields may need to be updated.

3. The Reverse Conundrum: Fed Cuts, Bond Yields Rise

Since the September 2024 FOMC meeting, the Federal Reserve has cut rates by 100 basis points. Over the same period, the 10-year Treasury yield has risen by 100 basis points. This phenomenon, termed the ‘reverse conundrum,’ represents the most significant disconnect between short-rate policy and long-end pricing in decades.

3.1 Contributing Factors

Factor	Impact on Long-End Yields
Foreign Official Selling	$113B reduction in dollar reserves since Sep 2024. Foreign share of Treasuries down to ~30% from 50%.
Rising Term Premium	Investors demanding more compensation for duration risk due to fiscal concerns, inflation uncertainty, and political risk.
Fiscal Deficit Expansion	Federal debt to exceed GDP in 2026. Record net issuance of $1T+ expected. Social Security cliff moved forward to 2030.
Japanese Repatriation Risk	Japan holds $1.2T in U.S. Treasuries. Rising JGB yields may incentivize domestic reinvestment over U.S. purchases.
Fed Independence Concerns	DOJ investigation of Powell, political pressure for rate cuts, new Fed Chair appointment in May 2026.
Sticky Inflation	PCE above 2% target for 4+ years. Tariff effects and services inflation persisting near 3%.

3.2 The Marginal Buyer Has Changed

Domestic private investors, including commercial banks, now represent approximately 55% of Treasury demand, up from a smaller share when foreign official institutions were the dominant marginal buyers. This shift matters because domestic private investors are more price-sensitive than foreign central banks, meaning they demand higher yields to absorb incremental supply. The era of yield-insensitive official sector buying suppressing long-end rates appears to be over.

4. Federal Reserve Policy Outlook

4.1 Rate Path

The Fed held rates steady at its January 2026 meeting. Markets currently expect two to three additional 25-basis-point cuts in 2026, likely beginning in June, bringing the federal funds rate to a range of 2.75%-3.0%. However, the path is highly uncertain:

• Inflation remains above target: PCE hovering near 3%, well above the 2% goal, with tariff effects and services inflation proving sticky.
• Labor market weakening: Payroll growth has slowed significantly, and the unemployment rate has risen to 4.4-4.5%. Fed Chair Powell has noted employment data may be overstated.
• Consumer inflation expectations are becoming unmoored: St. Louis Fed research indicates expectations remain elevated far above pre-pandemic trends.

4.2 The Independence Crisis

The most consequential Fed development in 2026 is the escalating threat to central bank independence. The Department of Justice served the Fed with grand jury subpoenas in January 2026 concerning Chairman Powell’s congressional testimony. Powell characterized the investigation as a pretext intended to pressure policymakers into lowering interest rates.

Powell’s term as Chair expires in May 2026. President Trump has stated unequivocally that his nominee will need to enact an agenda of sharply lower interest rates. However, Powell’s 14-year term as a Fed governor runs until 2028, and he may choose to remain on the board. Even if the new Chair pursues aggressive easing, they would be one of twelve voting members on the FOMC.

Former Treasury Secretary Janet Yellen, in a January 2026 address at the American Economic Association, explicitly warned about threats to Fed independence and the risk of fiscal dominance. Multiple institutional investors have flagged Fed independence as a key downside risk to market functioning in 2026.

4.3 The Policy Trap

The Fed faces a classic policy trap: the labor market argues for continued easing, but inflation persistence and fiscal concerns argue against it. Cutting rates aggressively would risk unanchoring inflation expectations and accelerating the long-end selloff. Holding rates too high risks a sharper labor market deterioration. The bond market is effectively telling the Fed that its credibility premium is eroding, as evidenced by the rising term premium and the widening gap between short rates and long yields.

5. Equity Market Implications

5.1 Near-Term Support Factors

• AI capex boom: Remains the defining equity theme. Data center investment backlogs are large and earnings growth from AI-related companies continues to outperform.
• Fiscal stimulus: The ‘One Big Beautiful Bill Act’ tax cuts and deregulation provide tailwinds to corporate earnings.
• Broadening participation: Wall Street consensus expects earnings growth to extend beyond mega-cap tech in 2026.

5.2 Medium-Term Risk Factors

Risk Factor	Transmission Mechanism	Severity Assessment
Rising Term Premium	Higher discount rate compresses equity multiples, especially for long-duration growth stocks	HIGH: 10Y at 4.3% with upside risk to 4.5%+. Each 50bps adds meaningful valuation drag.
Fed Politicization	Markets demand political risk premium; volatility spikes; VIX projected above 20	HIGH: DOJ investigation and May 2026 Chair transition create binary event risk.
Yield Curve Steepening	Historically signals late-cycle stress; increases cost of capital for leveraged entities	MODERATE: Steepening from rate cuts is constructive; steepening from long-end selloff is not.
Japanese Capital Flows	Repatriation reduces demand for U.S. Treasuries, pushes yields higher	MODERATE: JGB 40Y at record highs. $1.2T in holdings at risk of gradual reallocation.
AI Valuation Risk	Concentrated market driven by AI capex; any slowdown in returns-on-investment could trigger correction	MODERATE: Capex remains strong but scrutiny on ROI increasing. Speculative leverage in data centers noted.

5.3 Tail Risk Scenario

If Fed independence is seriously compromised and a politically-appointed Chair cuts aggressively while inflation remains elevated, the likely sequence would be: an initial equity rally on easing expectations, followed by an acceleration in gold and commodities, a sharp long-end bond selloff as bond vigilantes demand higher compensation, and ultimately an equity correction as the resulting financial instability overwhelms the stimulus effect. Historical parallels include Turkey (2018-2023) and Argentina, where politically-motivated monetary easing led to currency debasement, capital flight, and eventual equity market crashes in real terms.

6. The Macro Feedback Loop

The interconnected dynamics form a self-reinforcing feedback loop that represents the central macro risk of 2026:

1. Rising fiscal deficits increase Treasury supply
2. Foreign official buyers declining reduces demand at the long end
3. Term premium rises, pushing long-end yields UP despite Fed cuts
4. Gold absorbs safe-haven flows as Treasury credibility erodes
5. Fed independence under threat creates political risk premium
6. Higher yields increase debt service costs, expanding deficits further
7. Loop repeats with accelerating intensity

The Congressional Budget Office has estimated that a sustained 20-basis-point increase in the 10-year Treasury rate could result in a $702 billion increase in net interest payments over a 10-year period. With yields already elevated and supply accelerating, the fiscal arithmetic is deteriorating rapidly.

7. Key Signals to Monitor

Signal	What to Watch	Threshold / Trigger
10Y-FFR Spread	If spread keeps widening while Fed cuts, bond market is repricing credibility	Spread above 150bps signals structural concern
Gold/TLT Ratio	Rising ratio = safety bid migrating from Treasuries to gold	New highs confirm structural rotation
30Y Treasury Yield	Approaching 5% is a key psychological and technical threshold	Sustained break above 5% could trigger forced selling and volatility cascade
Fed Chair Transition	Powell’s term ends May 2026. Nominee’s stance on independence is critical	Markets pricing political risk premium via VIX, gold, and FX
Japan 40Y JGB Yield	Record highs in JGB yields may pull capital from U.S. Treasuries	Watch for sustained Japanese repatriation flows
Consumer CPI Expectations	St. Louis Fed flagged potential unanchoring of inflation expectations	5Y/5Y forward breakevens rising above 2.5% is warning signal

8. Conclusion and Positioning

The Great Rotation from long-duration Treasuries to gold is not a contrarian trade. It is the consensus being expressed through the largest capital flows in modern financial history. The corroborating evidence is overwhelming: record bond fund inflows concentrated in short/intermediate duration, record gold demand from both institutional and retail investors, declining foreign official Treasury holdings, a rising term premium despite Fed cuts, and escalating threats to central bank independence.

For equity markets, the near-term picture remains supported by AI-driven earnings growth and fiscal tailwinds. However, the medium-term risks are building as the term premium compresses equity valuations, political uncertainty injects volatility, and the fiscal feedback loop intensifies. The key variable is whether the rising cost of long-term government borrowing creates a financial stability event that overwhelms the growth impulse.

The most important signal to monitor is the spread between the 10-year Treasury yield and the federal funds rate. If this spread continues to widen while the Fed cuts, it will confirm that the bond market has lost confidence in the fiscal trajectory and the Fed’s ability or willingness to maintain price stability. In that environment, gold outperformance will accelerate, long-duration assets will underperform, and equity volatility will increase materially.

Sources

Morningstar Fund Flows (Jan 2026), State Street ETF Flash Flows (Jan 2026), ICI Weekly Fund Flows, Breckinridge Capital Q1 2026 Outlook, J.P. Morgan Gold Research, World Gold Council Gold Demand Trends, CEPR VoxEU, CNBC, Bloomberg, Charles Schwab Fixed Income Outlook, CME Group Precious Metals Outlook, Fidelity Bond Market Outlook, Vanguard Active Fixed Income Perspectives Q1 2026, KPMG Economic Compass Jan 2026, Stanford SIEPR, Brookings Institution, BondBloxx 2026 Outlook, ING Think, Bipartisan Policy Center.

Disclaimer: This research note is produced by DAIFO (dafo.biz) for informational purposes only and does not constitute investment advice, a solicitation, or an offer to buy or sell any securities. The analysis is based on publicly available data and third-party sources believed to be reliable but not independently verified. Past performance is not indicative of future results. All investments involve risk, including loss of principal. Readers should consult qualified financial advisors before making investment decisions.