(Bloomberg) — For those unsettled by the relentless rise in government bond yields in the US and across much of the world lately, the message from markets is getting clearer by the day: Get used to it.
The world’s biggest bond market and global bellwether is leading a reset higher in borrowing costs, with the prospect of a prolonged period of elevated rates carrying consequences for economies and assets everywhere.
Just days into 2025, yields on US government debt are surging as the risks to supposedly super-safe assets mount. The economy continues to power ahead — Friday’s blowout employment report provided the latest evidence — while the Federal Reserve is rethinking the timing of further interest-rate cuts and Donald Trump is returning to the White House with policies prioritizing growth over debt and price fears as borrowing has soared.
The rate on 10-year notes alone has soared more than a percentage point in four months and now is within sight of the 5% barrier last breached briefly in 2023 and otherwise not seen since before the global financial crisis nearly two decades ago.
Longer-dated US bonds have already touched that milestone, with 5% seen by many on Wall Street as the new normal for the price of money. Similar spikes are playing out internationally, with investors increasingly wary of debt from the UK to Japan.
“There is a tantrum-esque type of environment here and it’s global,” said Gregory Peters, who helps oversee about $800 billion as co-chief investment officer at PGIM Fixed Income.
For some, the shift upward in yields is part of a natural realignment after years of a near-zero rate environment following the emergency measures taken after the financial crisis and then Covid. But others see new and worrisome dynamics that present major challenges.
Given its role as a benchmark for rates and signal of investment sentiment, the tensions in the $28 trillion US bond market threaten to impose costs elsewhere. Households and businesses will find it more expensive to borrow, with US mortgage rates already back at around 7%, while otherwise upbeat stock investors are beginning to fret higher yields could be a poison pill for their bull market.
Corporate credit quality, which has remained generally strong amid the benevolent economic backdrop, also risks deterioration in a higher-for-longer environment.
Historians point out that rising 10-year note yields have foreshadowed market and economic spasms such as the 2008 crisis as well as the previous decade’s bursting of the dot-com bubble. And while the ultra-low rates of recent years allowed some borrowers to lock in favorable terms that have helped shield them from the latest yield surge, pressure points may build if the trend persists.
US yields are rising even after the Fed joined other major central banks in embarking on a course of rate cuts — a jarring disconnect that has few precedents in recent history. That easing of US monetary policy that started in September was expected to continue in lockstep with a slowing economy and inflation, setting up bonds to rally.
Instead, the economy has stayed solid, as is seen by December’s jump in jobs growth, and the resilience has sown doubts over just how far and how fast inflation can slow. The Fed’s favored inflation gauge rose 2.4% in the year through November, way below its pandemic-era peak of 7.2% but still stubbornly above the 2% comfort level of central bankers. Wednesday sees the release of December's consumer price index, which is predicted to show underlying inflation cooling only slightly.
Consumers remain on guard: The latest sentiment reading from the University of Michigan revealed inflation expectations for the next five to 10 years at the highest since 2008.
Several Fed policymakers recently signaled they support keeping rates on hold for an extended period. In markets, swaps reflect a similar viewpoint, with the next quarter-point cut not fully priced in until the second half of the year. A number of Wall Street banks on Friday trimmed their forecasts for 2025 cuts in the wake of strong jobs data. Bank of America Corp. and Deutsche Bank AG don’t see the Fed easing at all this year.
“The Fed doesn't have much room to even talk about cutting rates in the near term,” Kathy Jones, chief fixed income strategist at Charles Schwab & Co Inc., said on Bloomberg Television Friday.
The continued pricing out of Fed rate cuts this year only compounds the poor performance of US government bonds compared to riskier assets such as stocks. The Bloomberg Treasury index has started the year in the red and is down 4.7% since just before the Fed’s first cut in September, compared with a 3.8% gain for the S&P 500 and a gain of 1.5% for an index of Treasury bills. Beyond the US, a global index of government bonds has lost 7% since shortly before the Fed cut in September, extending the decline since the end of 2020 to 24%.
The recalibration in rate expectations also helps explain why, according to Deutsche Bank, 10-year Treasuries are suffering their second-worst performance during 14 Fed easing cycles since 1966.
Enter the Vigilantes?
Monetary policy is only part of the picture, though. As US debt and deficits pile up, investors are becoming increasingly fixated on fiscal and budgetary decisions and what they may mean for markets and the Fed, especially ahead of this month’s return of Trump and a Republican-run Congress. Tellingly, the term “bond vigilantes” — a decades-old moniker for investors who seek to exert power over government budget policies by selling their bonds or threatening to do so — is cropping up again in commentary and conversations on Wall Street.
The fiscal footprint is already huge. The nonpartisan Congressional Budget Office estimated last year that the budget shortfall is on track to exceed 6% of gross domestic product in 2025, a notable gap at a time of solid growth and low unemployment. Now Trump’s preference for tariffs, tax cuts and deregulation sets the stage for even bigger deficits, as well as the potential for accelerating inflation.
As politicians “apparently have zero appetite for fiscal tightening, the bond vigilantes are slowly waking,” said Albert Edwards, global strategist at Société Générale SA. “The argument that the US government can borrow in extremis because the dollar is the world’s reserve currency surely won’t hold good forever.”
As for the debt burden, the vast stimulus in the wake of the pandemic sent it skyrocketing, part of a global trend. Led by the US, the outstanding government debt among the Organization for Economic Co-operation and Development, a group of the most advanced economies, increased by 35% to $54 trillion in 2023 from 2019. The debt-to-GDP ratio of the OECD nations jumped to 83% from a pre-pandemic level of 73%.
It’s not stopping there: Bloomberg Economics projects the US debt-to-GDP ratio will reach 132% by 2034 — what many market watchers see as an unsustainable level.
Into this mix comes Trump. While he, Treasury Secretary-nominee Scott Bessent and supporter Elon Musk have all lambasted the nation’s sea of red ink, they also back policies which risk adding to it in the belief they will spur growth and thus tax revenues. The Committee for a Responsible Federal Budget, a Washington-based watchdog, has estimated Trump’s economic plan, including renewing his 2017 tax cuts, would increase debt by $7.75 trillion above the current projected levels through fiscal year 2035.
PGIM Fixed Income’s Peters said he “wouldn’t be completely shocked at all” if 10-year yields rose beyond 5% in this environment, part of a growing camp who see yields resetting to a higher range. BlackRock Inc. and T. Rowe Price recently argued that 5% was a reasonable target as they expected investors would demand juicier rates to keep buying longer-dated Treasuries.
Pacific Investment Management Co. ended 2024 saying it was “less inclined” to purchase Treasuries with extended maturities in light of ballooning US deficits,” and advocated “vigilance before vigilantism.”
What Bloomberg strategists say:
“If 2024 was a lesson that monetary policy isn’t everything in driving bond-market returns, this year seems likely to cement that lesson by amping up the focus on fiscal policy and other government measures. These include things like tariffs, potential tax cuts, possible spending cuts, measures impacting the labor force, and issuance patterns.”
— Cameron Crise, macro strategist.
The more debt, the more issuance. On the present trajectory, the size of the bond market may almost double to $50 trillion over the next decade, adding supply at a time of nervous demand. Juggling that will likely be a challenge for Bessent, whose confirmation hearing before the Senate is schedule for Thursday.
Another headache for Bessent and the bond market: The impending hitting of the federal debt limit and pursuant political wrangling.
Budget concerns are playing out elsewhere around the globe. France and Brazil got attacked by investors at the end of last year and just last week UK gilt yields were propelled higher amid a protest over the nascent Labour government’s fiscal plans. At one point, the 30-year gilt yield spiked to its highest since 1998, leading some to draw parallels with the market meltdown witnessed during Liz Truss’s brief premiership of 2022.
“We will have some kind of fiscal type of bond market event sometime over the next couple years, said PGIM Fixed Income’s Peters. “There has to be some kind of governor of fiscal discipline and the bond market seems to be the only place where that can occur. The contours will be different of course — in countries — but the idea will be the same, ‘Hey government, we need to have faith in your abilities to focus on this situation.’”
While the US enjoys some insulation given its debt is traditionally the world’s safest-asset and the dollar dominates markets and commerce, warning signs of a permanent change in sentiment are flashing there too.
The so-called term premium on 10-year notes — the extra yield investors demand to accept the risk of taking on longer-term debt — is now at a more than decade high and, according to a Fed model, has become an increasingly bigger component of overall yields.
Meanwhile, yields on longer-dated debt have climbed faster than those of their short-term counterparts, a sign of concern for the long-term outlook.
“Rising term premium to us indicates a growing concern around the US fiscal path,” said Zachary Griffiths, head of US investment grade and macro strategy at CreditSights. “The steepening of the curve is also more consistent with the historical relationship between large and rising deficits.”
There are still some who see yields reversing, assuming the related tightening of financial conditions means the economy finally does buckle and the Fed can ease anew. Sustained declines in risk assets might also change the equation and stoke demand for bonds. On Friday, declines in the S&P 500 wiped out its early gains for the year.
“I just don’t believe in the idea that bond yields can keep rising without having an effect on the economic cycle,” said Brij Khurana, portfolio manager at Wellington Management.
And yield spikes can be fleeting. Bond markets are renowned for throwing tantrums — memorably in 2013 when the Fed said it would reduce bond purchases and in late 2023 when 10-year yields touched 5% — only to reach a point perceived as a buying opportunity that starts off a fresh rally.
To Jim Bianco, founder at Bianco Research, the rise in bond yields isn’t necessarily ominous. It’s how the world used to be before the financial crisis. He points out that 10-year yields averaged about 5% in the decade through 2007.
The real outlier, he said, was the post-2008 period, when rates were pinned to zero, inflation was persistently running low and central banks were buying massive amounts of bonds in response to the crisis. That lulled the new generation of investors to accept that a 2% bond yield and zero inflation-adjusted – or real — interest rate were “normal.”
The Covid shutdowns and the subsequent massive government stimulus reset the global economy and “changed things, frankly, for the rest of our life,” Bianco said. The consequence is persistently higher inflation, around 3%, and a 2% inflation-adjusted interest rates. Adding them together produces a 5% rate that Bianco says looks about right. He expects 10-year yields to move toward the 5% to 5.5% range.
Some note there are structural reasons behind the shift higher in yields that signal a paradigm shift as opposed to a return to normal.
In a report this month, strategists at JPMorgan Chase & Co. listed de-globalization, an aging population, political volatility and the need to spend money fighting climate change as reasons to expect the 10-year note to yield 4.5% or higher in the future. For Bank of America, US Treasuries are already well into the latest “Great Bond Bear Market,” the third in 240 years after a decades-long bull run that ended in 2020, when rates touched an all-time low during the start of Covid lockdowns.
