Major challenges: Treasury secretary nominee Bessent (centre) walks through Capitol Hill in Washington. Along with Musk, he has lambasted the nation’s sea of red ink, and backed policies that they believe will spur growth and thus tax revenues. — Reuters
NEW YORK: For those unsettled by the relentless rise in government bond yields in the United States 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. Last Friday’s blowout employment report provided the latest evidence, while the Federal Reserve (Fed) is rethinking the timing of further interest rate cuts and Donald Trump is returning to the White House with policies prioritising 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 US$800bil 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 US$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 favourable 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 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 favoured 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.
Tomorrow 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 signalled 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 last 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.
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.
Monetary policy is only part of the picture, though.
As US debt and deficits pile up, investors are becoming increasingly fixated on financial 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 financial footprint is already huge.
The non-partisan 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 financial 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 Organisation for Economic Co-operation and Development (OECD), a group of the most advanced economies, increased by 35% to $54 trillion in 2023 from 2019.
The debt-to-gross domestic product (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. — Bloomberg
