Quick Bites | US Treasury Yields Becoming Concerning

The bond market has been signaling for some time that investors may be too complacent. At some point, this will become a major concern for sharemarkets. We guess that a 5% yield for US 10-year Treasuries if reached too quickly, might become a catalyst for a correction of sorts.

Last week, the trigger was a strong monthly jobs report in America. The US economy added 256,000 jobs in December, well above the 155,000 predicted. That, along with higher-than-expected inflation readings in recent months, reduces the odds that the US Federal Reserve (Fed) will lower rates at its next two meetings, later this month and in March.

This shift in expectations has been one of the forces driving Treasury yields steadily higher. Other concerns include fears over high budget deficits and the possibility that new tariffs under the Trump administration could further spur inflation. The yield on benchmark 10-year Treasury notes at the time of writing was around 4.7%, well up from 3.6% in September last year. Both the 10-year and the 30-year yields are at their highest levels since November of 2023.

US Treasury yields rising closer to the 5% level and yield curve normalises

Source: Yardeni Research 

The higher bond yields rise, the less attractive equity valuations become. One way of assessing this is to examine the equity risk premium – namely, the excess return that investing in the stock market provides over a “risk-free” rate. This excess return compensates investors for taking on the relatively higher risk of equity investing. As the chart below shows, the spread of the S&P 500 earnings yield over the 10-year Treasury yield has disappeared (and gone into negative territory) as the share market has risen and bond values have declined (indicating shares are very expensive relative to bonds).

Source: Bloomberg 

The pain caused by the bond sell-off has not been confined to the US. The United Kingdom bore the brunt last week, with benchmark 10-year British Gilt yields reaching their highest level since 2008. Sluggish economic growth and expectations of more borrowing under its new Labour government have meant the UK is suffering a major slump as the government’s interest costs lurch upwards. Last month, French bond yields were the focus of financial markets as President Macron endured a political imbroglio. And in Australia, the trend has been similar with yields on 10-year bonds rising from 4.35% a month ago to 4.65% in mid-January.

UK gilts in free fall as yields rise to 25-year highs

Source: Bloomberg

The global uncertainty is unlikely to ease as President Trump enters the White House and enacts his proposed tariffs. While the inflationary effects of levies would be felt in the US primarily, the disruption of supply chains could have unpredictable consequences for other stock markets.

Meanwhile, the world will also have to deal with the effects of China’s economic struggles. In the absence of sufficient stimulus to kick-start domestic demand, Chinese exports are likely to keep rising, exporting deflation around the world and hitting global manufacturers. Bond yields in China have recently crossed below Japanese bond yields for the first time in decades in a historic shift signalling the momentous changes occurring (see chart below).

Source: Bloomberg

Judging by the yields on Chinese bonds, investors have all but given up hope that the world’s second-largest economy will rebound anytime soon. Yields on Chinese bonds seem to be in a determined slide, not what one would expect if the government were about to introduce a big economic stimulus plan. Thus, while most global bond yields are steadily climbing, Chinese bond yields are falling in a vote of no confidence in the Chinese economy.

With the two largest global economies pulling in different directions, the rest of the world is caught between them. This will require delicate maneuvering and a close watch. Expect more volatility this year.