Bond yields rose this month to levels that have begun to alarm financial markets. The yield on the 30‑year US Treasury reached 5.20% on 19 May, the highest level since mid‑2007, just before the 2008–09 financial crisis. The 10‑year yield exceeded 4.68% on the same day before easing slightly, but remaining above 4.50%. The trend is global. Yields on UK gilts, German Bunds and Japanese government bonds are also moving higher, in parallel with rising oil prices following the outbreak of war with Iran in late February. However, as Barron’s analysis underlines, recent movements are part of a long-term upward trend that began when long-term interest rates hit historic lows in 2020, during the peak of the pandemic.
What distinguishes the current situation is that long-term interest rates have now reached levels capable of exerting significant pressure on equity valuations. Major stock indices remain just below their record highs, reflecting investor enthusiasm for artificial intelligence, which may intensify further as some of the largest AI companies prepare for stock market listings. Higher bond yields increase competition for equities and simultaneously raise borrowing costs for companies.
The immediate cause of the recent decline in the bond market, as prices move inversely to yields, is the rise in oil prices due to the continued disruption of passage through the Strait of Hormuz. US crude prices (WTI) nearly doubled, reaching close to $113 per barrel on 7 April, up from around $67 on 27 February, one day before the war began.
Oil prices have since eased towards $100, however even at these levels they create inflationary pressures that may prove persistent.
The three main reasons for rising yields
Robin Brooks, senior fellow at the Brookings Institution and former chief economist at the Institute for International Finance, identifies three main reasons for the rise in yields, which has pushed the US 10‑year bond from around 0.50% in 2020 to current levels: governments almost everywhere engaged in heavy borrowing to deal with the economic effects of the pandemic, there has been no meaningful reduction in deficits since then, and inflation remains higher and more volatile than in the pre‑Covid period.
Total US federal debt exceeded 100% of GDP in the first quarter of the year, approaching the historic peak of 106% after the Second World War. The Congressional Budget Office estimates that the fiscal deficit will reach 5.8% of GDP in 2026. The future trajectory is seen as even more concerning, as the CBO forecasts that the US deficit will average 6.1% of GDP annually through to 2036, far above the 50‑year average of 3.8%.
The tense geopolitical environment is further boosting military spending, meaning many countries may need to issue even more debt. Investors, in turn, are likely to demand even higher yields. The Trump administration is seeking a 44% increase in military spending for fiscal year 2027, reaching a record $1.5 trillion. At the same time, US European allies and Canada increased military spending by more than 20% in 2025 and committed to raising such spending to 5% of GDP by 2035.
An even greater burden on public finances is the sharp increase in debt‑servicing costs from previous years of heavy borrowing. In the United States, annual interest costs have already exceeded $1 trillion, now surpassing current military spending.
As for inflation, it has retreated from its 2022 highs but remains elevated and volatile. As a result, central banks are forced to implement more frequent and larger interest rate increases to contain inflation expectations.
Futures markets now price in a 70% probability of at least one rate hike by the Federal Reserve by December, according to the CME FedWatch Tool. This marks a sharp reversal from earlier expectations of more than two rate cuts by year-end.
Economists at J.P. Morgan estimate that the European Central Bank and the Bank of Japan will raise interest rates in June, while another increase by the Bank of England is also considered likely.
A serious warning signal
Currency analysts at Brown Brothers Harriman note that when government borrowing costs exceed nominal GDP growth, that is, economic growth including inflation, this constitutes a serious warning sign. In the United Kingdom this has already occurred, with the 10‑year gilt yielding nearly 5%, above the average nominal GDP growth of the past decade, which stands at around 4.8%.
The situation is considered even more dangerous in Japan, where the yield on the 10‑year government bond has surged above 2.50%, the highest level since mid‑1997, after years of artificially low interest rates. Average nominal GDP growth in Japan over the past decade stands at just 1.9%.
The US strategy that could backfire
Developments in global bond markets also directly affect the United States. “For years, foreign investors, deprived of yields in their domestic markets, channelled capital into US bonds,” Yardeni Research recently noted. “As yields rise internationally, this incentive weakens. The US must now compete for debt buyers in a world of high deficits and rising inflation.”
The US Treasury attempted to limit borrowing costs by shifting debt issuance towards short‑term Treasury bills instead of medium- and long-term bonds with higher yields. This strategy began in 2022 under former Treasury Secretary Janet Yellen and was criticised at the time by current Treasury Secretary Scott Bessent, who nevertheless maintained it upon taking office.
This tactic worked in Washington’s favour while the Fed cut short-term interest rates by 1.75 percentage points in 2024 and 2025, but it may prove to be a boomerang if the central bank returns to raising rates.
In the short term, bond yields will continue to depend on the course of the war in Iran and the reopening of the Strait of Hormuz. Due to US midterm elections and the importance of fuel prices to voters, markets are pricing in a decline in oil prices. However, even if this occurs, underlying inflation, particularly in services, remains persistent.
In the long term, the burden of debt will continue to weigh on developed economies. There is no evident serious intent to reduce deficits, while governments continue to borrow for social spending, defence and energy investment, and the investment boom in artificial intelligence is also increasing corporate borrowing.
The fear of 6%
Reflecting these trends, 62% of participants in Bank of America’s latest fund manager survey expect the yield on the 30‑year US Treasury to exceed 6% over the next 12 months. Such a surge would likely put significant pressure on equities, potentially leading to a temporary rally in bond markets. However, according to analysts, this would be unlikely to be sustained.
Source: newmoney.gr
