Why high bond yields look like the new normal

GOVERNMENT borrowing costs have been climbing around the world, as investors demand more compensation to entice them to hold longer-maturity debt.

The rise in US bond yields even prompted US Treasury Secretary Scott Bessent to announce expanded buybacks of long-dated government debt – an intervention that failed to stop yields on 10-year Treasuries from surpassing 5 per cent and hitting their highest point in almost two decades.

That is one of the many milestones the bond market has notched in recent weeks, suggesting that the era of low yields could be coming to an end. Globally, the average yield on sovereign debt has reached 4 per cent, a level last seen in 2007.

Investors’ retreat from long-dated government debt has been driven by a range of concerns.

These include mounting fiscal deficits and stubborn inflation amid US President Donald Trump’s trade war and higher energy costs due to the conflict in the Middle East.

Governments are also having to compete for investor attention. as technology companies issue massive amounts of debt to fund the build-out of artificial-intelligence infrastructure.

What is special about long bonds?

Bonds issued by wealthy nations are widely regarded as the world’s safest securities, because these governments are highly likely to pay investors back.

Governments often lock in financing costs for long periods such as 30 years. Some even issue debt that matures in a century.

There are still risks for investors. Should inflation and short-term interest rates rise, that eats into the real value of a bond’s coupon payments, as well as the principal that is repaid when the bond reaches its maturity date.

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The longer the tenor of a bond, the more time there is for inflation to have an impact. That is why long-dated bonds have been more sensitive to the rise in interest rates and inflation, and why they have been at the centre of the recent sell-off.

In September, yields on 30-year US Treasuries hit their highest level since 2004, while Japanese peers were close to all-time highs and UK equivalents reached their highest point since 1998.

Would investors not want to buy long bonds at high yields?

In theory, yes, although the bond market is facing a structural shift in supply and demand. For much of the past two decades, abundant global savings – particularly in Asia – chased a relatively scarce supply of safe assets, helping suppress long-term real yields.

Now, governments around the world are ramping up spending on everything, from renewable energy to defence.

The US is borrowing more to fund its more than US$40 trillion in national debt, as well as to plug an annual fiscal shortfall that the Congressional Budget Office estimated in August will reach US$2.1 trillion.

While global supply of government debt has swelled, demand has been curtailed by weaker foreign appetite and central banks reducing their bond holdings after years of purchases.

The investor base is shifting towards more price-sensitive private buyers, who typically demand higher compensation to hold long-term bonds. Structural changes in pensions and retirement systems have also shrunk the pool of traditional long-term buyers.

How much of a premium are investors demanding for long bonds?

The so-called term premium for 30-year US sovereign bonds – the extra yield that investors demand to hold long-term debt – has increased by more than three percentage points from the low reached in 2020 during the Covid-19 pandemic, going by a model developed by Bloomberg Economics.

The US has traditionally enjoyed a “convenience yield”, whereby investors were willing to pay higher prices – and accept lower payouts – because of the liquidity, safety and usefulness of Treasuries as collateral.

Some say that privilege has been eroded, indicating the ever-increasing national debt load and Trump’s erratic policymaking. Others argue that the concern is exaggerated and Treasuries remain the safest debt out there.

Why are long-end yields important to the economy?

A disorderly bond-market sell-off can spell trouble for governments that rely on debt markets to finance their deficits – something the UK is all too familiar with, after the collapse of Liz Truss’s premiership in 2022.

Long bond yields underpin interest rates on a litany of consumer loans such as mortgages, as well as corporate debt. Higher bond yields risk increasing pressure on household borrowers, when years of inflation have already made the cost of living less affordable.

Savers, however, enjoy a boost.

The pass-through to consumer debt markets is not always straightforward.

In the US, 30-year mortgage rates are priced closely off the 10-year Treasury yield, instead of the 30-year Treasury rate. That is because homeowners tend to pay off or refinance their mortgages after a period that is closer to 10 years.

What can governments do about the rise in long bond yields?

Many governments are tilting their borrowing programmes towards shorter maturities. While yields are currently lower there, the shorter tenor of those bonds means they need to be refinanced more frequently – possibly in the face of higher interest rates.

The US Treasury announced in August that it would expand its buybacks of 10 to 30-year government bonds, to break what Bessent called a “fever” in the market. But the first tranche of buybacks was smaller than expected, and 10-year yields went on to reach multi-year highs.

Fundamentally, governments need to convince investors that they will get inflation and their fiscal deficits under control. That could involve a combination of tax hikes and spending cuts that are unpopular with voters.

Should investors be worried about the surge in yields?

To some degree, higher yields are good news for bondholders. With equity markets hovering around record highs, the rise in yields reflects a resilient global economy that can absorb higher borrowing costs.

Yields were near zero in the aftermath of the global financial crisis, when the outlook for economic growth was poor. The recent increase in yields could be viewed as a normalisation to pre-crisis levels.

“People love to use the phrase ‘higher for longer’,” Wells Fargo economists Tom Porcelli and Michael Pugliese wrote in a research note in August. “We would argue a far better characterisation is normal for longer.” BLOOMBERG