The strength of the US economy and the risk of persistent price pressures have fueled a surge in bond yields as investors rethink the trajectory for global interest rates.
A global bond sell-off pushed benchmark US 10-year Treasury yields close to their highest level since 2007 last week to around 4.35%, while equivalent Australian bonds rose to 4.30%, UK gilt yields hit the highest since 2008 and 10-year French government bonds reached levels not seen since 2012. German Bunds — viewed as a benchmark for Europe — have risen by 0.15% to 2.62%.
The rise in yields, which move inversely to prices, comes on the back of data that suggests the US economy is stronger than previously thought and, in turn, inflation will take longer to moderate. That has prompted investors to push out their expectations for when central banks will be able to start cutting interest rates.
The moves have caught out some investors who were getting back into the bond market to lock in the yields on offer, believing that rates had peaked.
Apart from economic strength in the US and persistent inflation, are there other factors driving yields higher?
A few weeks ago, the Bank of Japan stepped back from yield curve control, allowing long-suppressed Japanese government bond yields to rise. International bond markets responded negatively, expecting further increases in Japanese yields to lift all boats, as higher returns at home encourage Japanese investors to sell foreign bonds and repatriate capital.
But US yields have risen more significantly than other major markets, implying US-based drivers are at play. Factors include:
- Fading recession fears. Recent growth data has surprised on the upside, while inflation has cooled. Given the normal range of “long and variable lags” between tightening financial conditions and recession ensuing, the US economy is not out of the woods, but the rising chance of a soft landing being achieved will have removed some demand for Treasuries and pushed yields higher.
- More Treasury supply. The suspension of the debt ceiling restriction has allowed the US government to start issuing debt again. The Treasury will offer USD1 trillion of new bonds this quarter alone, and barring a change in fiscal policy, the US government’s indebtedness will keep rising in the coming years. It was this reality that led to the recent downgrade of US government debt by ratings agency Fitch.
- Tight monetary policy, including quantitative tightening. With inflation moderating, the Federal Reserve may soon have the option to stop hiking interest rates. But if the US economy stays strong, it will keep those rates elevated. That would allow investors to keep earning higher yields on short-term instruments rather than on long-dated bonds. Meanwhile, quantitative tightening continues, meaning the price-sensitive private sector must digest more of the growing Treasury supply.
These drivers could keep US yields higher for longer.
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