Long-duration bonds are at the epicenter of investor anxiety, as markets fear everything from persistent inflation increases to the debt-fueled investment boom in artificial intelligence.
Governments are now being called upon to pay the price, as sovereign borrowing costs are accelerating almost everywhere in the world.
This week, the yield on the 30-year US Treasury rose to its highest level since 2007, while France's borrowing costs reached their highest levels since 2008.
Benchmark German bonds are trading at levels unseen since 2011.
In Britain, yields on corresponding government gilts are approaching 6%, while in Japan, yields on bonds of equivalent maturity sit near their all-time high.
Global bond crisis
Although domestic factors play a role in each market, the structural forces driving yields higher are global in nature.
The first factor is the fear that an increasingly fragmented global order will render economies more vulnerable to supply shocks and persistent inflationary pressures.
Concurrently, bond investors worry that governments will fail to rein in public spending, keeping economic activity elevated and interest rates higher for longer.
At the same time, market structural changes and demographic developments are limiting demand from investors who historically provided a stable source of buying interest.
This represents an especially difficult environment for finance ministers, many of whom are shifting debt issuance toward shorter maturities where yields are lower.
However, room for maneuver is limited, as governments adapt to a world where they can no longer «lock in» their funding costs for decades at ultra-low interest rates.
«Difficult to predict when yields will improve»
«It is hard to know at what yield level the outlook for total returns on long-duration fixed-income bonds would improve», said Chris Iggo, chief investment officer of AXA IM Core at BNP Paribas Asset Management.
«The only thing that could change this picture would be a sudden deterioration in economic data or some sort of external shock. The latter seems more likely than the former», he added.
Global debt markets have taken a heavy blow this year from the surge in energy prices triggered by the conflict in the Middle East.
This development has reinforced bets that the Federal Reserve and other central banks will be forced to maintain or even increase monetary tightening.
However, the problem for fixed-income investors began before the latest turmoil.
Recent price action shows that another factor is pushing long-term bond yields higher.
US: 30-year bond hits 5.32%
Yields on 30-year US Treasuries have risen by nearly 40 basis points since late June, reaching 5.32% on Tuesday.
This marks the highest level since mid-2007.
The development presents a serious headache for President Donald Trump and Treasury Secretary Scott Bessent ahead of the midterm elections, as elevated funding costs for the US Treasury gradually feed through into corporate and consumer loans.
«The November elections could introduce new policy risks and will certainly focus market attention on fiscal matters ahead of the regular budget drafting period», said Iggo of AXA.
«Ideally, one would not want to enter a major election cycle with mortgage rates rising, even if they remain lower than 2023 levels», he added.
Not just the US Treasuries market
The US government bond market represents only one piece of the broader picture.
The average yield on an investment-grade sovereign bond portfolio index has surged to nearly 4.5%, reaching its highest level since 2015, according to data compiled by Bloomberg.
One factor acting as a counterweight to long-duration sovereign bonds globally is competition from corporate issuers.
The pace of corporate bond issuance has reached record levels, adding substantial supply of long-dated paper to US fixed-income markets.
Activity is particularly intense among tech companies seeking financing for massive investments in artificial intelligence and opting to borrow for longer durations.
Artificial intelligence expands debt supply
American corporations are increasingly turning to overseas bond markets as well.
A prime example is Alphabet Inc., which decided to proceed with its first Australian dollar debt issuance, totaling A$5 billion (approximately US$3.6 billion).
The issue of increased bond supply arrives at a time when the buyer base is also shifting.
Traditionally, many bond markets relied on demand for long-term paper from pension funds, which used these bonds to match their assets against future liabilities.
Today, however, many providers are moving away from defined-benefit schemes, while regulatory changes encourage funds to increase their equity exposure.
Private investors take on a larger role
More broadly, as governments increase sovereign debt issuance, states rely increasingly on private investors.
Minutes from the Federal Reserve's June monetary policy meeting show that officials were briefed on the shift in the ownership base of US Treasuries.
The market is shifting from «official sector holders, relatively price-insensitive, toward private investors who are more price-sensitive».
This transition can impact the term premium, the additional compensation investors demand to hold longer-duration debt.
«Official demand is largely driven by policy objectives, whereas private investors are more yield-sensitive», said Anshul Pradhan, head of US rates strategy at Barclays Plc.
According to him, the shift in buyer composition over the past decade accounts for approximately 90 basis points of the term premium on 30-year US Treasuries.
Japan: Fresh wave of rising yields
In Japan, absolute yields remain lower than those in peer markets, but their recent ascent has been relentless.
The country's relatively steep yield curve reflects expectations that the Bank of Japan has waited too long to raise interest rates to tackle inflationary pressures.
This is compounded by other concerns, including the central bank's decision to taper its bond-buying program, alongside fears of increased government spending and higher energy costs.
«The prospect of rising imported energy inflation and mounting pressure on the Bank of Japan to hike rates offer little incentive for investors to return to the JGB market», said Prashant Newnaha, senior Asia-Pacific rates strategist at TD Securities in Singapore.
«Japan was supposed to serve as the anchor for global interest rates. The risk of JGB yields moving higher increases the risk of repricing debt duration globally», he added.
Inflation is not the only driver behind the sell-off
Although inflation concerns have driven a significant portion of the bond market sell-off, long-term break-even rates, which capture market expectations for future inflation, have remained relatively stable across most major markets.
Instead, the increase in borrowing costs has been driven primarily by real yields.
This reflects the additional compensation investors demand, beyond inflation protection, to hold bonds.
JPMorgan sees buying opportunity
The market repricing may, however, create a potentially attractive entry point for fresh investment capital, according to Kelsey Berro, portfolio manager at JPMorgan Asset Management.
«Where we have seen greater value emerge and where we feel slightly more positive is at the long end of the curve, particularly in real yields», she said.
«We believe correlations could ultimately work in favor of the portfolio if we were to see broader turmoil across higher-risk assets», she added.
The environment remains exceptionally demanding for governments and investors alike.
The era of near-zero interest rates, cheap money, and the ability to «lock in» sovereign debt for decades appears to have passed, as explosive growth in public and corporate financing needs collides with a market increasingly reluctant to absorb long-term debt at low yields.
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