Since the beginning of this year, almost every sector in the bond market has strengthened, including Treasuries, high yields, munis and preferreds.

“That doesn’t normally happen—long Treasuries producing double-digit returns along with high yield at the same time,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “At some point the market will need to recalibrate.”

Could Tuesday’s bond market selloff, in tandem with the sharp decline in stocks, indicate the start of that recalibration?

Jones thinks so. “The prospect of less monetary stimulus going forward means markets not only have to reprice interest rates risk but also credit risk. It can probably extend further. Given that the term premium has been negative, there is room for bond yields to rise and credit spreads to widen.”

The yield on the 10-year Treasury note, which moves in the opposite direction of its price, jumped to 1.73% Tuesday, its highest level in three months as a Bank of America survey showed investors boosting cash levels to their highest level in almost 15 years. The 10-year finished the session at 1.72%.

Jones and her colleague, Collin Martin, director of fixed income at Schwab’s Center for Financial Research, are cautioning investors against reaching for yield, which has led many to pour money into emerging market debt and high yield debt in order to collect more income.

According to Bank of America Merrill Lynch’s latest weekly data, inflows into emerging market debt over the past 10 weeks were the biggest ever. High yield bond funds had positive inflows for the past 9 out of 10 weeks, and investment grade bonds funds saw positive inflows for the past 26 out of 27 weeks. In comparison, government bonds had their largest outflows in the past six months.

The bank’s survey of fund managers showed a net 54% of respondents said bonds and stocks are both overvalued, which was the highest level since May 2000.

Schwab analysts are not yet underweight emerging market or high yield bonds because of their relatively high coupons, but they are cautious because spreads to Treasuries are tight. The average spread of the Barclays Aggregate High Yield spreads to Treasuries is 4.9% currently, compared to 5.5% historical average, said Martin at a morning meeting with reporters. These tight spreads suggest investors aren’t being paid to take the additional risk.

(Related: Gundlach: Time to Be ‘Defensive’ With Bonds)

Emerging market debt faces the additional risk of a potential increase in the U.S. dollar as the Fed raises rates, which would make it more difficult for those issuers to service their dollar-denominated debt. A Fed rate increase and dollar strengthening could potentially be the catalyst for Schwab to underweight emerging market, said Jones. “We are not fans of emerging market debt.”  

In comparison, Amer Bisat, managing director of emerging markets at BlackRock’s Americas Fixed Income Group, is a fan, and BlackRock has been overweight emerging markets since early March, when emerging market bonds got “extremely cheap compared to core bond holdings,” said Bisat.

Emerging market debt, said Bisat, has been “underowned for at least three years” and became more attractive in the first quarter because of “the absence of negative news along with some positive news.” He referenced stability in the oil market and the U.S. dollar and some “green shoots of growth” such as the pickup in Asian manufacturing exports.

“Growth is at the core of the emerging market story,” said Bisat, noting that money flows into the sector have been “enormous” and include “tourist money”—money from investors who don’t usually buy into that market but are attracted now to the cheap valuation. So long as the valuation story remains intact and the fundamentals continue to improve, Bisat expects demand for emerging market bonds will remain strong and possibly increase.

Investment grade corporate bonds face a different risk—a rising default rate and increased leverage. Defaults in that sector have been increasing every month since mid-2014 while spreads have been narrowing, said Martin. “Corporate bonds are not too healthy, fundamentally speaking.”

Corporations have been issuing more debt and pushing out short-term maturity risk, but the proceeds are not being used to grow companies. They are being used instead to pay shareholders in dividends or higher stock prices due to buybacks, or just sitting in cash because rates are so low, said Martin.

Higher yields down the road would make it harder for companies to repay this debt.

Schwab is neutral on investment grade as well as high yield debt and overweight core holdings such as Treasuries, agencies and intermediate term high quality bonds and underweight international bonds given their low or negative yields. Owning such bonds “makes no sense unless you think the dollar will go down or negative rates will increase around the world,” said Jones.

BlackRock, in contrast, favors international debt, including emerging market bonds, because of the growing demand for yield in a world where rates are expected to remain low for a long time, which also leads to increasing leverage and risk. On that outlook both BlackRock and Schwab agree.

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