Image Source: Pexels

Too often equity investors ignore developments in the bond market, until the consequences appear inevitable. Global bond markets are experiencing a steady upward move in rates, especially in the 10yr and 30yr segments. Each country has a specific set of factors which account for the rise in sovereign debt yields, but many share a common set of conditions that now produce this upward swing in yields that is finally getting the attention it deserves. Common to all bond markets, yields are considerable higher over the past year.When the US 30yrs topped 5% the other day, some alarm bells went off in the US Treasury market. As it stands, the long end of the market does not provide much comfort for borrowers in the public and corporate sectors. 

Governments can no longer assume that their long-term debt will be taken up readily at auction. Ed Yardeni,who coined the term “bond vigilantes” believes “the bond market has never been more powerful, because we’ve never had so much debt”. 

The surge in rates over the past 12 months has been most challenging to bondholders as they adjust their portfolios.For example,

• US 30yr bond yield is 77 bps above last year; the Fed continues to deal with inflation and is reluctant to drop its rates;
• UK 30yr gilt yield has gone up a full 100 bps as that nation deals with financing growing deficits and high inflation;
• Germany 30yr yield has jumped 55pbs, in the midst of inflationary pressures in the Eurozone;
• Canada’s 30yr bond yield has risen by 75 bps, closely aligned with that US market changes; although Canada continues to have much subdued rate of inflation; and
• Japan 30yr bond yield has risen more than 100 bps; given Japan’s historically low yields, this upward swing is even more noticeable among traders.

The prospects of a glut in the supply of sovereign debt in each country plays the most important role in pricing. As economies slow and fiscal policies continue to result in large deficits, the market is expecting a surge in new government debt which will drive yields upward. Even though the US, for example, is going to rely heavily on short-term issuances to take care of a record-setting deficit in the next two years, the longer end of the bond market will experience pressure. In addition, the corporate world is in constant need of funding, creating competition to an already stressed government market.

At the same time, the demand for long term government has been slowing as central banks have reversed course. During the crisis of the pandemic, central banks were very focussed on keeping the lid on yields. Now, the tables are turned as deficit-financing puts considerable pressure on the government bond auctions.

Central banks would like to lower their overnight rates, but inflation targets have yet to be reached. Only Canada and Germany experience inflation at the target rate of 2%, while the other major economies have considerably more work to get there. The surge in US tariffs has yet to be felt in the domestic markets. Industries are struggling with how to price imported components. While the corporate sector, so far, has absorb the bulk of the tariffs, it is just a matter of time before the tariffs hit the consumer.In short, the outlook for inflation remains very unclear, leaving the central banks very much out on a limb.

Although much more difficult to qualify, President Donald Trump’s attacks on Federal Reserve independence only add more worry to bond holders. Should he succeed in getting the Fed to doing his bidding and keep borrowing costs artificially low, the bond market would build in a yield premium to offset long-term inflation. The stage is set for higher long- term borrowing costs.

More By This Author: