Quick Bite – Rising Bond Yields Threaten Markets
Stock market investors are not quite sure what to make of President Trump’s on-again, off-again tariffs. Yet despite the uncertainty, they have staged impressive rallies to be within around 5% or so of all-time highs.
Source: Yardeni Research
Apart from tariffs, another source of anxiety is disturbing market confidence – and that is recent turbulence in the bond markets – the most important of which is the US Treasury market which sets the tone for most other bond markets.
Treasuries were disturbed by the Moody’s downgrade, which while it did not overly move yields, brought the focus back to the ballooning US budget deficit. Also, recent US bond auctions have been met with weak demand. The long-end of the yield curve got sold off, with the US 10-year Treasury yield rising beyond 4.5% and the US 30-year Treasury note above 5.0%.
Source: Yardeni Research
Why the nervousness in bond markets? Let’s give a bit of background and context.
In the decade after the global financial crisis, inflation was stubbornly low across all major economies. This encouraged the belief that interest rates would always be low, no matter how much debt governments ran up.
This thinking persisted and informed global policy making when the pandemic hit in 2020. Governments everywhere ran much bigger deficits than previously deemed sensible and global indebtedness rose sharply. Encouraged by the illusion that interest rates would always be low, governments after the pandemic never got deficits back under control, with government debt issuance being far bigger than before COVID. This recklessness is now haunting the world.
Source: Robin Brooks
Although most commentators tend to focus on 10 year bonds, it’s the very long end of the yield curve where risk premia are most important, and why we note the 30-year government bond yields in the chart above.
Long term yields in the US are up, but the truth is that what’s going on in the US is almost modest compared to the UK or Japan, where – in both cases – the 30 year yield is now at its highest level going back all the way to 2000. The global debt binge during and after COVID is exacting a price, with global yields rising sharply. Poor fiscal policy is a global problem, not just a US problem.
We note the case of Japan, where the recent rise in the 30 year yield is extreme. When Japanese bond yields were low, this encouraged Japanese households to seek higher yields overseas. Some of the resulting capital outflow from Japan went into US Treasuries, helping keep longer term US interest rates low. With the sharp rise in Japan’s 30-year yield, this dynamic is reduced, which adds to upward pressure on longer term US yields. In effect, the rise in Japanese interest rates is exporting Japan’s high debt level to the rest of the world.
Source: Robin Brooks
As one would expect, there is a relationship between the level of government debt and that country’s bond yields. Looking at the chart above, it would not be surprising if Japanese bond yields rise even further, as they have lots of ground to make up compared with other advanced countries and considering their extreme level of government debt.
Considering that Japan’s government debt is 240% of GDP, its yields are still very low. That’s because of the Bank of Japan, which from 2012 to 2024 bought all of Japan’s net new debt issuance. That is changing and is adding to the pressure pushing up yields.
Source: Robin Brooks
High debt levels are not unique to Japan. They are endemic across most advanced economies and mean pressure on central banks to cap yields is rising. Will we start seeing Quantitative Easing in the US once again?
