What is happening in the bond market in the past week is something that every trader and investor should stand up and take notice. While there is still a heavy focus on the US-Iran conflict, the stock market and AI, as well as central banks, the bond market might well be sending a big message to broader markets at the moment.
And that is we should be prepared for a new era in fixed income. One that will be defined by higher-for-longer interest rates and yields.
For the longest of time now, markets have grown accustomed to the landscape of low yields and low inflation. That led to the era of easy money, which was only exacerbated by the Covid pandemic.
But fast forward to a couple years later now, the scars are starting to show and they are ugly. Persistent inflation dynamics and ballooning fiscal debt/deficits. That is a nasty combination that is leading to a tectonic shift in the bond market.
This week alone, we’re seeing bond yields at these levels:
- US 10-year yields:4.80%, highest since January 2025 and October 2023
- Germany 10-year yields:3.37%, highest since April 2011
- France 10-year yields:4.24%, highest since November 2008
- UK 10-year yields:5.26%, highest since June 2008
- Japan 10-year yields:3.02%, highest since September 1996
This is no singular story. It is a wave across the globe.
So, what exactly is happening?
The straightforward explanation is that we are seeing major economies now run massive and unprecedented levels of budget deficits. And that has a twofold impact on the bond market.
The first being that when a government spends significantly more than it collects in revenue, it must borrow the difference by issuing government bonds. That leads to a flood of new supply in the market, thus lowering bond prices and pushing up yields.
The second is to do with duration risk. When national debt relative to GDP surges, investors will demand a term premium in order to compensate for long-term fiscal volatility and/or policy instability. Hence, another reason for surging bond yields as fiscal risks continue to pile up. Just look at what is happening with Japan now. That is a fine and perfect example since Takaichi took over as prime minister.
And when you add in the fact that we’re seeing persistent geopolitical uncertainty, one which has a massive impact on inflation expectations especially, it’s creating quite the perfect storm for bond vigilantes to play in.
Just with higher deficits alone, it means that central banks will have to keep interest rates higher to try and curb deficit-driven inflation. But now you add in a prolonged geopolitical conflict that affects the globe by impacting energy prices and raw materials, it just speeds up any inflation problems that are already taking shape.
And this is not even talking about the long-term and bigger picture outlook of demographics, amid an aging population in developed economies, yet. That’s a conversation we’ll save for another discourse.
If there’s only one spot that you can pay attention to in markets this week, this it very much it.
The message from the bond market is a scary one and one that could potentially ripple through other markets soon enough. That especially if bond vigilantes win out to establish the narrative that we are truly in a new era now.
Typically, that doesn’t bode well for stocks/equities. But in a time when things can move very quickly, I’d be wary of it rapidly hitting hard at leveraged funds and becoming more of a risk event.
This article was written by Justin Low at investinglive.com.